Risk-free interest rate
What is the risk-free interest rate?
The risk-free interest rate is the rate of interest paid on the least risky financial instruments, normally considered to be the shortest-dated risk-free bond. For instance, in the U.S. the risk-free interest rate is generally assumed to be that paid on a three-month Treasury bill.
Where have you heard about the risk-free interest rate?
You should have heard about the benefits of investing in risk-free assets from your broker. Although the interest rates on longer-dated government bonds are assumed to be risk-free because of the extremely low chance of default, investing in bills that only have three months to run further lowers that chance.
What you need to know about the risk-free interest rate.
It’s important to remember that no bond is ever totally risk-free as there is always a small chance of a government defaulting on its debt, as Russia did in 1998. However, the chances of the government of a financially stable country defaulting on their sovereign debt are tiny. For the investor, particularly in an already low-rate environment, the low risk of these instruments means an extraordinarily low rate of return, often close to zero. In extreme cases, such as short-dated bills in Switzerland, rates can become negative and you end up paying to invest in an ultra-safe asset.