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