Risk-free rate
The risk-free rate is the return on an investment with no default risk, usually taken as the yield on short-term US Treasury bills. Every riskier investment should promise more than it.
It is the baseline in finance models such as CAPM and Black-Scholes. The extra return investors demand over it for taking risk is called the risk premium.
Related terms
- Capital asset pricing model (CAPM): The capital asset pricing model says an investment's expected return equals the risk-free rate plus its beta times the market's extra return over that rate.
- Black-Scholes model: The Black-Scholes model is a formula for the fair price of a European option using five inputs: the stock price, strike, time to expiry, risk-free interest rate and volatility.
- Bond: A bond is a loan to a government or company that pays the lender interest (the coupon) and returns the full amount (the face value) at a set date.
- Interest rate: An interest rate is the price of borrowing money, stated as a percentage of the loan per year.
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