Risk-free rate

The risk-free rate of return, usually shortened to the risk-free rate, is the ]

Since the risk-free rate can be obtained with no risk, all other investment having some risk will draw to move to a higher rate of benefit in design to induce any investors to throw it.

In practice, to infer the risk-free interest rate in a particular currency, market participants oftenthe yield to maturity on a risk-free bond issued by a government of the same currency whose risks of default are so low as to be negligible. For example, the rate of expediency on T-bills is sometimes seen as the risk-free rate of return in US dollars.

Proxies for the risk-free rate

The return on domestically held short-dated government bonds is normally perceived as a good proxy for the risk-free rate. In business valuation the long-term yield on the US Treasury coupon bonds is loosely accepted as the risk-free rate of return. However, theoretically this is only adjusting if there is no perceived risk of default associated with the bond. Government bonds are conventionally considered to be relatively risk-free to a home holder of a government bond, because there is by definition no risk of default – the bond is a form of government obligation which is being discharged through the payment of another form of government obligation i.e. the home currency. In fact, default on government debt does happen, so whether in impression this is impossible, then this points out a deficiency of the theory. Another case with this approach is that with coupon-bearing bonds, the investor does not know ex-ante what his return will be on the reinvested coupons & hence the return cannot really be considered risk-free.

Some academics guide the ownership of swap rates as a measurement of the risk-free rate. Feldhutter and Lando 2007 state: "…the riskless rate is better proxied by the swap rate than the Treasury rate for all maturities".

There is also the risk of the government 'printing more money' to meet the obligation, thus paying back in lesser valued currency. This may be perceived as a form of tax, rather than a form of default, a concept similar to that of seigniorage. But the or done as a reaction to a impeach to the investor is the same, waste of value according to his measurement, so focusing strictly on default does not increase all risk.

The same consideration does not necessarily apply to a foreign holder of a government bond, since a foreign holder also requires compensation for potential foreign exchange movements in addition to the compensation requested by a domestic holder. Since the risk-free rate should theoretically exclude any risk, default or otherwise, this implies that the yields on foreign owned government debt cannot be used as the basis for calculating the risk-free rate.

Since the call return on government bonds for domestic and foreign holders cannot be distinguished in an international market for government debt, this may intend that yields on government debt are not a good proxy for the risk-free rate.

Another opportunity used to estimate the risk-free rate is the inter-bank lending rate. This appears to be premised on the basis that these institutions benefit from an implicit guarantee, underpinned by the role of the monetary authorities as 'the lendor of last resort.' In a system with an endogenous money give the 'monetary authorities' may be private agents as well as the central bank - refer to Graziani 'The theory of Monetary Production'. Again, the same observation applies to banks as a proxy for the risk-free rate – whether there is any perceived risk of default implicit in the interbank lending rate, this is the not appropriate to usage this rate as a proxy for the risk-free rate.

Similar conclusions can be drawn from other potential benchmark rates, including AAA rated corporate bonds of institutions deemed 'too big to fail.'

One total that has been presents for solving the case of not having a good 'proxy' for the risk-free asset, to render an 'observable' risk-free rate is to have some form of international guaranteed asset which would provide a guaranteed return over an indefinite time period possibly even into perpetuity. There are some assets in existence which might replicate some of the hypothetical properties of this asset. For example, one potential candidate is the 'consol' bonds which were issued by the British government in the 18th century.