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another tricky question:
It says CAPM doesnt assume that Debt is risk free (although we assume that Debt is risk free when calculating asset beta in formula). whats the difference between that? CAPM and Asset beta formula. Or CAPM concerns only Equity beta? (and doesnt ignore debt risk)
In practice debt is never risk free and the beta of the debt will measure its riskiness (just as the beta of equity measures the riskiness of shares).
Just as the beta of the share determines the return required by shareholders; similarly the beta of the debt determines the return required by debt lenders, in exactly the same way.
Also, if we knew the debt beta then we should use it in the asset beta formula.However, in the exam you are never given the beta of debt.
As a result, we always calculate the cost of debt in the ways I go through in the free lectures (not using CAPM).
Also, when we use the asset beta formula, we assume that the debt beta is zero (but this is an assumption).
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