Session 6: Risk, Riskfree Rates and Equity Risk Premiums (a start)

We started this class by tying up the last loose ends with risk and return models, talking about how assuming that there are no transactions costs and private information can lead us all to hold the market portfolio, and how risk can be then measured as risk added to that portfolio. We did damn the CAPM with faint praise, arguing that it does not do very well at explaining differences in returns across companies, but that it does at least as well as the alternatives. We then started on the mechanics of the model, taking about risk free rates: how to estimate the risk free rate in a currency where there is no default free entity issuing bonds in that currency and why risk free rates vary across currencies. The key lesson is that much as we would like to believe that riskfree rates are set by banks, they come from fundamentals - growth and inflation. I have a post on risk free rates that you might find of use:
http://aswathdamodaran.blogspot.com/2015/04/dealing-with-low-interest-rates.html
In fact, risk free rates turned negative in a few currencies, upending what we know about risk free rates in. Here is my post on negative risk free rates.
http://aswathdamodaran.blogspot.com/2016/03/negative-interest-rates-unreal.html
In the final few minutes of the session, we turned to equity risk premiums and how they are related to risk aversion.
Slides: https://pages.stern.nyu.edu/~adamodar/podcasts/cfspr23/session6slides.pdf
Post class test: https://pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session6atest.pdf
Post class test solution: https://pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session6asoln.pdf