Glossary

The risk-free rate is the theoretical return on an investment with zero risk, typically represented by the yield on government bonds.

It is used as a benchmark for comparing other investments, as it is assumed that there is no risk of default with government bonds. The risk-free rate is an essential component in various financial models and calculations, such as the Capital Asset Pricing Model (CAPM) and the calculation of risk premiums. 📈🛡️

For example, the yield on a US Treasury bond or a UK government gilt can be considered a risk-free rate. In practice, the risk-free rate is often approximated using the yield on a short-term government bond.

Fun fact: Despite being called the "risk-free rate," government bonds do carry some risks, such as interest rate risk, inflation risk, and, in some cases, even default risk. However, these risks are usually considered minimal compared to other types of investments. 💱