US downgrade - Risk free rate ? triple

Wasteoftime

Its interesting to watch, the RFR is an important concept in financial theory, and many formulas out there. If the US is downgraded does this make the RFR irrelevant in many financial formulas using US treasury's?

long-term U.S. government bonds are often used as the proxy for the risk-free rate in asset pricing models. Higher Treasury rates would then lead directly to higher discount rates, and that would reduce the fair value estimates of equities across the board. Although going from triple A to double A may not see huge swings in interest rates to matter for the RFR to change...

OR

may search for foreign debt to seek safe heaven and a 'risk free rate'. Going foreign will cause formulas to become inaccurate having to adjust for inflation measures and so forth becoming pretty complex. Its interesting to see how the next couple years play out if the US keeps getting downgraded because of our debt.

Whats your guys thoughts of this?



Edited 2 time(s). Last edit at Thursday, July 28, 2011 at 12:09PM by Johnnyboyasu.

bdavi77962

freecmorgan, globally you would be right that the net effect of investors fleeing from US treasuries to other debt investements might be negligible to nil, IF debt were everything...

...however, risk-averse investors would more likely turn to gold (or similar) as a dependable store of value, albeit non-yielding. It is therefore quite conceiveable that a flight from "quality" debt would raise the real (and nominal) interest rate, with commodities benefiting correspondingly.

meghanjackson

The RFR will be replaced by the zero beta portfolio...

mp3bu

Part of me wants to laugh at how we try to justify our prices based on discount rates. The risk free assumption is the least of our worries. What does the discount rate matter if you mess up your cash flow projections--or if the market disagrees with you? Assumptions, expectations, luck, and a way out when we want it--that's really the game we're all interested in, isn't it?

That's my two cents, here's the other:

Been thinking of this for a while. If the U.S. decides not to raise the debt ceiling, people are saying interest rates will go up. I'm wondering if this is in fact true. By that, I mean, is there enough high quality paper floating around in the world to satisfy the demand of investors. If suddenly, there are no new treasuries, won't investors have to buy something else--agencies, corporates, mbs's, muni's etc? Wouldn't that demand for other paper actually drive down the cost of borrowing for the private sector, regardless of what happens to treasury yields?

noel

RFR would still be used, it would just have to be estimated as US Treasury Bond rate - some sort of default spread.