Cost of Capital

us_beta_102us_beta_102
in Odomirok.25-Solv2

Is this a typo when you write:
cost-of-capital = 9%
risk-free rate = 2%
illiquidity premium = 1%
→ cost-of-capital above risk-free rate = (R - i) = 9% - (2% - 1%) = 3%

I think you mean 9% - (2%+1%) = 6%?

Also I notice the following things:
1. The risk-free here is 2%, different than the given risk-free of 0.625% in Spring 2017 Q20 problem. Same for illiquidity charge. Can you please explain why?
2. Is this correct to think that Technical Provision includes Best estimates of Liabilities and the cost of holding required capital (SCR x (R-i)%) ?

Comments

  • grahamgraham

    Thanks, I've corrected the typo to 9% - (2% +1%).

    For your Q1, I jumped back to a problem from chapter 23, 2016.Fall Q18 which is where the risk-free rate of 2% came from. I've made that clearer in the wiki and provided links back to the relevant discussion and problem. It was just to illustrate a point that was similar to 2017.Spring Q20.

    For Q2 about the technical provision, you're close, but you also have to discount the cost-of-capital for each year then sum discounted values. I have added my solution to the wiki article that hopefully makes this clearer.

  • us_beta_102us_beta_102

    Thanks, Graham! I like the way that you made a connection between chapter 25 and chapter 22-23 concepts.

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