Calculate the Risk Free Rate

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Risk-Free Rate Calculator

Typically the current yield of a 10-year Treasury note.
The projected annual increase in price levels.
The calculated Real Risk-Free Rate is:
0.00%
function calculateRFR() { var nominal = parseFloat(document.getElementById('nominalYield').value); var inflation = parseFloat(document.getElementById('inflationRate').value); var resultDiv = document.getElementById('rfr-result'); var resultValue = document.getElementById('rfr-value'); var resultExplanation = document.getElementById('rfr-explanation'); if (isNaN(nominal) || isNaN(inflation)) { alert("Please enter valid numerical values for both yield and inflation."); return; } // Using the Fisher Equation: (1 + Nominal) = (1 + Real) * (1 + Inflation) // Real = [(1 + Nominal) / (1 + Inflation)] – 1 var nominalDecimal = nominal / 100; var inflationDecimal = inflation / 100; var realRateDecimal = ((1 + nominalDecimal) / (1 + inflationDecimal)) – 1; var realRatePercentage = realRateDecimal * 100; resultValue.innerText = realRatePercentage.toFixed(3) + "%"; resultDiv.style.display = "block"; if (realRatePercentage < 0) { resultExplanation.innerText = "The negative real rate suggests that inflation is outpacing the yield, eroding purchasing power."; } else { resultExplanation.innerText = "This represents the purchasing power growth of an investment with zero default risk."; } }

Understanding the Risk-Free Rate

The Risk-Free Rate (RFR) is a fundamental concept in finance, representing the theoretical return of an investment with zero risk. While no investment is truly 100% risk-free in every sense, short-term government securities (like U.S. Treasury bills) are commonly used as a proxy because the government can print currency to meet its obligations, virtually eliminating default risk.

Why the Risk-Free Rate Matters

The RFR serves as the "baseline" for all other investments. In financial models like the Capital Asset Pricing Model (CAPM), the risk-free rate is the starting point to which a risk premium is added. If a risky stock doesn't offer a return significantly higher than the risk-free rate, investors have no incentive to take on the extra volatility.

  • Valuation: Used as the discount rate for cash flows in DCF models.
  • Opportunity Cost: Represents what you could earn by doing nothing with your money.
  • Economic Indicator: Reflects the central bank's monetary policy and inflation expectations.

Nominal vs. Real Risk-Free Rate

It is crucial to distinguish between the nominal rate and the real rate. The Nominal Rate is the percentage return you see on a bond quote. The Real Rate adjusts that figure for inflation. If a Treasury bond yields 4% but inflation is 3%, your actual purchasing power only grows by approximately 1%.

The Fisher Equation:
(1 + Nominal Rate) = (1 + Real Rate) × (1 + Inflation Rate)

Example Calculation

Suppose you are analyzing a 10-year Government Bond with a nominal yield of 5.0%. If the market expects the annual inflation rate to average 2.0% over the next decade, you can calculate the real risk-free rate as follows:

  1. Convert percentages to decimals: 0.05 (Nominal) and 0.02 (Inflation).
  2. Apply the formula: ((1 + 0.05) / (1 + 0.02)) – 1.
  3. Result: (1.05 / 1.02) – 1 = 0.0294 or 2.94%.

In this scenario, while you receive a 5% cash return, your wealth only increases by 2.94% in terms of what you can actually buy.

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