Portfolio Weighted Risk-Free Rate Calculator
Calculate the effective risk-free yield of a diversified bond portfolio.
Total Portfolio Value: 0
Portfolio Composition:
How to Calculate Risk Free Rate of a Portfolio
In modern finance theory, the "Risk-Free Rate" typically refers to the theoretical return of an investment with zero risk of financial loss. While usually represented by a single benchmark (like the 10-year U.S. Treasury Note), real-world portfolios often hold a mix of different risk-free assets, such as T-Bills, T-Notes, and T-Bonds, each with different maturities and yields.
To accurately assess the baseline performance of such a portfolio, you must calculate the Weighted Average Risk-Free Rate. This metric provides a more precise hurdle rate for your specific allocation than a generic market benchmark.
The Calculation Logic
Calculating the risk-free rate of a portfolio involves weighting the yield of each risk-free asset by its proportion to the total portfolio value. The formula is:
Weighted Rate = ( (V1 × R1) + (V2 × R2) + … + (Vn × Rn) ) / Total Portfolio Value
Where:
V = Value of the specific asset
R = Yield (Rate) of the specific asset
Step-by-Step Calculation Example
Imagine a conservative portfolio holding three types of government securities. Here is how you would determine the effective risk-free rate:
- Asset 1 (Short-term T-Bills): $50,000 invested at 4.25% yield.
- Asset 2 (Medium-term Notes): $30,000 invested at 3.80% yield.
- Asset 3 (Long-term Bonds): $20,000 invested at 3.50% yield.
1. Calculate Total Value:
$50,000 + $30,000 + $20,000 = $100,000
2. Calculate Weighted Contribution for each:
Asset 1: $50,000 × 0.0425 = $2,125 (Annual Income)
Asset 2: $30,000 × 0.0380 = $1,140 (Annual Income)
Asset 3: $20,000 × 0.0350 = $700 (Annual Income)
3. Sum Contributions:
$2,125 + $1,140 + $700 = $3,965
4. Divide by Total Value:
$3,965 / $100,000 = 0.03965 or 3.97%
Why This Matters
Understanding the weighted risk-free rate is crucial for:
- Sharpe Ratio Calculation: When calculating the Sharpe ratio of your portfolio, using the specific weighted risk-free rate gives a more accurate measure of risk-adjusted return than using a generic market rate.
- Asset Allocation: It helps in understanding the income floor of your portfolio—the minimum return you can expect without taking on credit risk.
- Benchmarking: It serves as the true "zero-beta" benchmark for the rest of your risky assets (equities, corporate bonds).
Common Risk-Free Assets
When using this calculator, ensure you are inputting assets that are genuinely considered risk-free in your currency's context. For USD portfolios, this includes:
- Treasury Bills (T-Bills): Maturity of 1 year or less.
- Treasury Notes (T-Notes): Maturity of 2 to 10 years.
- Treasury Bonds (T-Bonds): Maturity of 20 to 30 years.