What is the “Riskless” (or Risk-Free) Rate of Return?

What is the “Riskless” (or Risk-Free) Rate of Return?

For comparisons of the risk/return ratio of an investment, one must start with a benchmark of a risk-free rate of return in the current market.

Since U.S. Treasury bills are backed by the full faith, credit, and taxing power of the U.S. Government, they are considered “riskless,” or as close to riskless as we can get. The current yield on a 10-year Treasury note is generally considered the risk-free rate of return.

This number becomes part of calculations which attempt to find an appropriate price for the amount risk and return present in other financial instruments. Any amount of risk above the risk-free rate amount is subject to the expectation of a “risk premium,” which exists for both debt and equity instruments.

In the case of debt/bonds, the yield on a bond must be compared with the current rate of the risk-free treasury note. In the case of equities, the risk premium will be the amount of return that will make it worth the investor’s “while” to take on the amount of risk present.

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