Definition
The risk-free rate represents the return an investor would expect from an absolutely risk-free investment. In practice, short-term U.S. Treasury bills are used as the proxy because the government has virtually no default risk. It serves as the baseline for calculating risk premiums and in models like CAPM.
Example
With 3-month T-bill yielding 4.5%, that's used as the risk-free rate for calculating equity risk premiums.
FAQ
What is Risk-Free Rate?
The theoretical return of an investment with zero risk.
Why is Risk-Free Rate important?
Risk-Free Rate helps investors evaluate valuation and make more informed decisions.