"There is no theoretical reason to select a short-term risk-free rate over a long-term risk-free rate,or vice versa in the CAPM or APT risk-expected return relation." Explain the statement.

Question

Quizplus · Accepted Answer

The Answer is In general,the use of the long-term versus the short-term risk-free rate in the CAPM or APT risk-expected return relation depends on practical considerations,not on the horizon of the cash flow.As an illustration,consider the valuation of a long-horizon certain cash flow.It is very clear that the yield of a default-free zero-coupon bond of matched horizon provides the appropriate rate for discounting the certain cash flow.This discounting is equivalent to finding a tracking portfolio which perfectly tracks the certain cash flow.For practical reasons,valuation with perfect tracking is generally more accurate than valuation using the market portfolio or factor portfolios.Thus,for a long horizon,the beta of the certain cash flow,measured over long horizons,is zero,and the risk-free rate is the long-term riskless rate.However,if one believes the CAPM is correct,it is also appropriate to track a long-horizon certain cash flow with short-horizon riskless bonds and the market portfolio.

"There Is No Theoretical Reason to Select a Short-Term Risk-Free