FM Chapter 20 Questions – Capital asset pricing model
15 Comments
M
Mo·
Thank you very much!
E
eceesay·
100%
Thanks John, i really am grateful.
S
SOLANKAR·
80percent
H
hlony·
Hi John,where did we get the 10% we multiplied the 70% of equity with?
J
John MoffatTutor·
In future, please say which question you are referring to.
We got 10% by using the CAPM formula on the formula sheet. It is risk free + (beta x market premium) which is 4% + (1.2 x 5%).
T
Teslim·
Hi John,
In Q4/5, could you kindly explain the reason that you used CAPM formula to calculate the cost of debt? I do not understand it. Thanks for your help always.
J
John MoffatTutor·
The question gave the beta of debt. The beta of anything measures its risk. Usually we assume that the beta of debt is zero and therefore risk free. However in real life debt is never completely risk free.
Just as the beta of equity determines the cost of equity, similarly the beta of debt determines the cost of debt (before tax).
T
Teslim·
Thank you sir.
J
John MoffatTutor·
You are welcome :-)
S
sheen·
Hi Mr. John,
Just wanted to say that the way you explain things is just amazing. And i was confused about q4 of chap 20 but after reading ur comment it got cleared.
I have a small question though, the E(r) can also be referred as required rate of return???
J
John MoffatTutor·
Thank you for the comment, and what you say about E(r) is correct.
A
artid1·
Hi
Please can you explain why in ch20 practise question 2 of 5 we don't deduct the risk free from the equity premium but we do deduct it from market return in question 1 of 5 of the test?
Look forward to your reply
Thank you
J
John MoffatTutor·
If you have watched the free lectures, then you will remember that the risk premium is the difference between the market return and the risk free rate.
If, for example, the market return is 10% and the risk free rate is 3%, then the risk premium is 7%.
In the exam, sometimes you are given the market return (in which case you need to subtract the risk free rate) and other times you are given the risk premium (in which case you don't subtract the risk free rate because it has already been subtracted).
Make sure you read the question carefully in the exam.
Thanks John, i really am grateful.
We got 10% by using the CAPM formula on the formula sheet. It is risk free + (beta x market premium) which is 4% + (1.2 x 5%).
In Q4/5, could you kindly explain the reason that you used CAPM formula to calculate the cost of debt? I do not understand it. Thanks for your help always.
Just as the beta of equity determines the cost of equity, similarly the beta of debt determines the cost of debt (before tax).
Just wanted to say that the way you explain things is just amazing. And i was confused about q4 of chap 20 but after reading ur comment it got cleared.
I have a small question though, the E(r) can also be referred as required rate of return???
Please can you explain why in ch20 practise question 2 of 5 we don't deduct the risk free from the equity premium but we do deduct it from market return in question 1 of 5 of the test?
Look forward to your reply
Thank you
If, for example, the market return is 10% and the risk free rate is 3%, then the risk premium is 7%.
In the exam, sometimes you are given the market return (in which case you need to subtract the risk free rate) and other times you are given the risk premium (in which case you don't subtract the risk free rate because it has already been subtracted).
Make sure you read the question carefully in the exam.
okay that makes sense
thank you!!