RISK FREE RATES
Start of session 4
Currency Risk Free Rates
1. You have a choice of valuing a Brazilian company in nominal Brazilian
Reais ($R) or US $. The risk free rate in Brazilian Reais is 7.5% and the
risk free rate in US $ is 2.5%. In which currency will you derive a higher
value for the company?
¤ In US $, since the risk free rate is lower, which will push down your discount rate
¤ In $R, because you will gain from exchange rate movements in your direction
¤ Neither. You should get the same value.
2. What if you were choosing between valuing your company in $R or in
real (no inflation) terms?
¤ In real terms, since the risk free rate is lower, which will push down your discount rate
¤ In $R, because you will gain from exchange rate movements in your direction
¤ Neither. You should get the same value.
2
Low Risk free Rates: The Fed’s Role
1. The US treasury bond rate, often used as the risk free rate in
US dollars, has been abnormally low for the last 10 years,
relative to the previous decade. This is because the Federal
Reserve has kept it low, with its quantitative easing.
¤ True
¤ False
2. The FOMC is meeting today to set rates. What they
do will determine whether interest rates will rise or
fall in the coming weeks.
¤ True
¤ False
3
Negative Interest Rates
1. In the last couple of years, there have been at least
three currencies where the long term government
bond rate in that currency has dipped into negative
territory. If this happens, you cannot do traditional
valuation.
q True
q False
2. The solution in this case is to replace the negative
interest with a normalized rate.
q True
q False
