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Estimating the cost of equity

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# 3.3 Calculating a risk-free rate

Complete the activity below to calculate a risk-free rate.

## Activity 3 Calculating a risk-free rate

Timing: Allow around 5 minutes for this activity

### Question 1

You are considering investing in an Indian company, in rupees.

Calculate a risk-free rate using:

• a.Bloomberg, which gives you the following figures for India:
• Return on the market = 13%
• Equity risk premium = 5%
• b.information given by a US bond rating agency about an Indian government bond, as follows.

The Indian government has a rupee-denominated bond that currently yields 14%. The US bond-rating agency (Standard and Poor’s) has given this bond a rating of A. The current spread over a risk-free rate, for an A-rated country, is 6%.

1. Estimate the rupee risk-free rate.

Hint: to arrive at a suitable risk-free rate, deduct the bond risk premium (6%) from the bond yield.

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#### Feedback

Using Bloomberg

The risk-free rate = 0.13 – 0.05 = 0.08 or 8%.

Using the Indian bond market and US rating agency

The risk-free rate = 0.14 – 0.06 = 0.08 or 8%.

According to Standard and Poor’s, Indian government bonds have a risk premium of 6% above the risk-free rate.

### Question 2

Government bonds are rated in the same ways as corporate bonds. In 2010, Greek ratings had a rating of BB+ compared to AAA for a US bond. Can you think why the ratings are different?