Risk-Free Rate

The theoretical return on an investment with zero default risk, typically approximated by government bonds.

Valuation & Pricing

Definition

The risk-free rate is the baseline return investors can earn with no credit risk. U.S. Treasury securities are the most common proxy. The 10-year Treasury yield is standard for equity valuation, while the 3-month T-bill rate is used for short-term analysis. The risk-free rate anchors all required return calculations in CAPM and WACC.

lightbulb Example

The 10-year U.S. Treasury yields 4.2%. This is used as the risk-free rate in CAPM: if beta is 1.0 and market risk premium is 5.5%, cost of equity = 4.2% + 1.0 × 5.5% = 9.7%.

verified_user Key Points

  • U.S. Treasuries are the standard proxy
  • 10-year yield used for equity valuation
  • Rising rates increase discount rates and reduce valuations
  • Currency-matched risk-free rates for international valuation

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