BAFI1045 Finance & Investment

22.Risk-Free Rate:Use10 years Govt. Bond Yield as a proxy for therisk-free rate. Indicate any advantages or disadvantages if there areany.3.Market Risk Premium: The estimation of the expected market riskpremium is crucial. You must carefully explain what you do and anyassumption you make while estimating market risk premium.•Risk Premium EstimationTo estimate the risk premium, first, you have to estimate the expected market return. Assume that expected return on the market portfolio is related to a Macroeconomic variable, e.g., GDP. Then use the expected changes in the macroeconomic variable, with appropriate possible returns and appropriate probabilities (assume these returns and probabilities based on your analysis of current economic condition) to estimate expected return on the market portfolio. Then, subtract the RFR from the expected market return and arrive at your market risk premium. Once you estimate these three figures (1-3) you will be able to estimate the required rate of return or discount rate following CAPM that can be used in valuation models. Important points to be covered in Part 2: •Explain any assumptions made in implementing the models.•Where appropriate, explain how you arrived at the variablesyou are using. E.g., it is not enough to say you are assuming a2% growth rate. You would be expected to providejustification/motivation of how you arrive at 2% growth rate.•Provide an indication of the sensitivity of your valuations tochanges in the assumptions. E.g. perform sensitivity analysisfor each mode