Hello Sir , In this question in 2nd part when Inflation increases by 2% whether Rf And Rm Both will change or only Rf will change by 2% ? Please explain the concept for the same once , thankyou
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Our required rate of return comprises 3 elements :
1. Opportunity cost for sacrifice of current consumption i.e. 9% (Rf real)
2. Compensation for loss of purchasing power due to inflation i.e. 2% (inflation premium)
3. Risk premium i.e. (Rm-Rf) and Rm is always nominal. This means it includes inflation premium.
So when inflation premium increases, we have to increase both Rf and Rm.This will result in no change in risk premium.
In CAPM, we have to add all the elements because it is an additive module but in all other areas we can use multiplicative model.
Thanku Brother But Icai only increases Rf and not RM , what to do in that case? Should we write both the solutions
Yes we can write both the solution