The rate of interest on the risk-free security (the risk-free rate) is one of the building blocks valuation professionals use in developing the cost of equity capital. Selection of the risk-free rate allows one to "scale" the cost of equity capital for the expected inflationary environment. But during late 2008 and early 2009 and again during the summer of 2010 risk-free rates were abnormally low and inconsistent with their theoretical formulation due to a "flight to quality."

Another key building block is the equity risk premium (ERP). Choice of the appropriate ERP as of the valuation date is one of the most important decisions the analyst must make in developing a discount rate. Any estimate of the ERP must be made in relation to a risk-free security. That is, the expected return on a fully diversified portfolio of equity securities must be measured in its relationship to the rate of return expected on a risk-free security.

The Great Recession of 2008-2010 has necessitated we reconsider many methods of analysis we took for granted during periods of stability. 1 The choice of a risk-free rate and estimate of ERP are just other examples of the difficulty in pricing risk during these uncertain economic times.

1 The recession technically began in December 2007 and lasted 18 months to June 2009, the longest since the 1929 crisis. But in many persons' opinion the recession continued, hence why this author is using the term the Great Recession of 2008-2010.

These sessions are available ONLINE ONLY.  This PDF and MP3 downloads will be available for 3 days after the purchase date.  Please download immediately.