Question

if you do not use treasury bills as the risk-free rate in the capm, what interest rate is normally used? multiple choice long term corporate bonds medium term bonds short term money market funds long term government bonds

Answer 1

In the CAPM, if Treasury bills are not used, the normal alternative is long term government bonds, such as 10-year U.S. Treasury bonds. Corporate bonds have higher interest rates but are riskier and thus not favored as the risk-free benchmark.

Step-by-step explanation:

If Treasury bills are not used as the risk-free rate in the Capital Asset Pricing Model (CAPM), long term government bonds, such as the 10-year U.S. Treasury bonds (officially called "notes"), are normally used as an alternative reference for the risk-free rate. Corporate bonds, while they pay a higher interest rate, are not typically used as the benchmark for the risk-free rate in CAPM because they carry a higher risk of default compared to government securities.

As depicted in Figure 17.5, the interest rates for corporate bonds and U.S. Treasury bonds are correlated, tending to rise and fall together. However, it is important to note that corporate bonds issue a higher interest rate to compensate for the greater risk, which contrasts with the lower-risk profile of long-term government bonds that are generally favored as a risk-free reference in CAPM.