What is 'Risk-Free Return'

Risk-free return is the theoretical rate of return attributed to an investment with zero risk. The risk-free rate represents the interest on an investor's money that he or she would expect from an absolutely risk-free investment over a specified period of time.

BREAKING DOWN 'Risk-Free Return'

In theory, the risk-free rate is the minimum return an investor should expect for any investment, as any amount of risk would not be tolerated unless the expected rate of return was greater than the risk-free rate.

In practice, however, the risk-free rate does not technically exist; even the safest investments carry a very small amount of risk. Thus, investors commonly use the interest rate on a three-month U.S. Treasury bill as a proxy for the risk-free rate because short-term government-issued securities have virtually zero risk of default.

RELATED TERMS
  1. Risk-Free Rate Of Return

    The theoretical rate of return of an investment with zero risk. ...
  2. Capital Allocation Line - CAL

    A line created in a graph of all possible combinations of risky ...
  3. Market Risk Premium

    The difference between the expected return on a market portfolio ...
  4. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected ...
  5. Option-Adjusted Spread (OAS)

    A measurement of the spread of a fixed-income security and the ...
  6. Cost Of Equity

    In financial theory, the return that stockholders require for ...
Related Articles
  1. Investing

    Risk-Free Rate of Return

    The risk-free rate of return is the theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free ...
  2. Investing

    How Risk Free Is The Risk-Free Rate Of Return?

    This rate is rarely questioned - unless the economy falls into disarray.
  3. Investing

    Calculating the Equity Risk Premium

    Equity risk premium is the excess expected return of a stock, or the stock market as a whole, over the risk-free rate.
  4. Managing Wealth

    How Interest Rates Affect Property Values

    Along with their impact on mortgages, interest rates affect capital flows, the supply and demand for capital, and an investor’s required rate of return.
  5. Investing

    What Investors Should Know About Interest Rates

    Understanding interest rates helps you answer the fundamental question of where to put your money.
  6. Investing

    What's the Option-Adjusted Spread?

    The option-adjusted spread, or OAS, measures a fixed-income security rate’s spread and the risk-free rate of return that’s adjusted to account for an embedded option.
  7. Investing

    Understanding The Sharpe Ratio

    This simple ratio will tell you how much that extra return is really worth.
  8. Investing

    Understanding Risk-Return Tradeoff

    The essence of risk-return tradeoff is embodied in the common phrase “no risk, no reward.”
  9. Investing

    Explaining the Capital Market Line

    The capital market line (CML) depicts the level of additional return above the risk-free rate for each change in the level of risk.
  10. Investing

    Mitigating Downside With The Sortino Ratio

    Differentiate between good and bad volatility with the Sortino Ratio.
RELATED FAQS
  1. How is it possible for a rate to be entirely risk-free?

    Find out whether there really is such a thing as a risk-free rate of return, and learn why taking the idea of risk-free rates ... Read Answer >>
  2. What is the correlation between equity risk premium and risk?

    Learn about the relationship between the risk-free rate of return and the equity risk premium, and understand how the risk-free ... Read Answer >>
  3. How accurate is the equity risk premium in evaluating a stock?

    Learn about the drawbacks of using the equity risk premium to evaluate a stock, and understand how it is calculated using ... Read Answer >>
  4. Is the market risk premium the same for stocks and bonds?

    Take a look at historical equity risk premium and credit spreads in the United States, which suggest that equities carry ... Read Answer >>
  5. How do I calculate the cost of equity using Excel?

    Learn how to calculate the cost of equity in Microsoft Excel using the capital asset pricing model, or CAPM, including brief ... Read Answer >>
  6. How is the expected market return determined when calculating market risk premium?

    Find out how the expected market return rate is determined when calculating market risk premium and how these figures are ... Read Answer >>
Hot Definitions
  1. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
  2. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  3. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
  4. Tax Refund

    A tax refund is a refund on taxes paid to an individual or household when the actual tax liability is less than the amount ...
  5. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
  6. Inflation

    The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of ...
Trading Center