Risk-Free Rate of Return Calculator
The risk-free rate of return is a theoretical rate of return of an investment with zero risk. It is used as a benchmark for evaluating other investments. The most common proxy for the risk-free rate is the yield on government bonds.
Results:
The calculated risk-free rate of return is: —
Understanding the Risk-Free Rate of Return
The risk-free rate of return represents the return an investor would expect from an investment with absolutely no risk of financial loss. In practice, achieving a truly risk-free investment is impossible. However, it serves as a crucial benchmark in financial analysis and investment valuation.
Proxies for the Risk-Free Rate:
- Government Bonds: The yields on government bonds (like U.S. Treasury bonds) are the most commonly used proxies for the risk-free rate. This is because governments are generally considered the most creditworthy entities, making the likelihood of default extremely low. The maturity of the bond (e.g., 10-year or 30-year) should ideally match the investment horizon being considered.
- Inflation Adjustment: While nominal bond yields are often used, it's important to consider the real risk-free rate, which accounts for inflation. The real risk-free rate is approximately the nominal risk-free rate minus the expected inflation rate. This provides a more accurate picture of the purchasing power an investor can expect to gain.
Why is the Risk-Free Rate Important?
- Discount Rate: It's a fundamental component of discount rates used in valuation models like the Discounted Cash Flow (DCF) analysis.
- Performance Benchmark: It helps investors assess the excess return (or risk premium) they are receiving for taking on additional risk in their investments.
- Capital Asset Pricing Model (CAPM): The risk-free rate is a key input in the CAPM, which is used to determine the expected return of an asset.
Calculation:
The nominal risk-free rate is typically represented by the yield on a government bond. To find the real risk-free rate, you can use the following approximation:
Real Risk-Free Rate ≈ Nominal Risk-Free Rate – Expected Inflation Rate
Our calculator uses this principle to give you an estimated real risk-free rate, assuming the long-term government bond yield is your proxy for the nominal risk-free rate.