Risk-Free RateRf
The risk-free rate is the return on an investment treated as having no default risk, usually proxied by short-term government bills such as US Treasury bills. It is the baseline every riskier investment must beat and a key input in CAPM, the Sharpe ratio and valuation.
Every investment decision starts with a quiet comparison: what could I earn without taking any real risk? That baseline is the risk-free rate. If a safe Treasury bill pays 4%, a risky stock that is expected to return 5% is not very attractive. This entry explains what the risk-free rate is, how it is measured, where it appears in finance formulas and why it is never perfectly risk-free.
- Category
- Bonds and Interest Rates
- Reading time
- 4 min
- Also called
- Risk-free rate of return, Risk-free interest rate
- Updated
The risk-free rate in plain words
In practice the risk-free rate is usually taken from short-term US Treasury bills, which mature in 4 to 52 weeks and are sold at a discount or at face value.1
For a bill, the "interest" is simply the difference between the price you paid and the face value you receive at maturity.1
In the CAPM, the expected return equals the risk-free rate plus a risk premium scaled by beta.2
How the risk-free rate is used, step by step
Pick a proxy
Usually a Treasury bill yield matching your horizon. See Treasury Bills, Notes and Bonds.
Match the time frame
Short horizons use bills; long valuations use longer bonds. See Yield Curve.
Set the hurdle
Any risky asset should be expected to beat it.
Measure excess return
Return minus the risk-free rate. See Sharpe Ratio.
Price risk
Add a risk premium in CAPM. See Capital Asset Pricing Model.
Discount cash flows
It anchors the discount rate. See Discounted Cash Flow.
Worked examples
Example 1 — A Treasury bill's yield
≈ 4.1% a yearYou buy a 26-week bill with a $1,000 face value for $980.
| Interest earned | $1,000 − $980 = $20 |
| Return over 26 weeks | $20 ÷ $980 ≈ 2.04% |
| Rough annual rate | ≈ 2.04% × 2 ≈ 4.1% |
Bills are bought below face value and repay face value at maturity; the difference is the interest.1
Example 2 — CAPM expected return
10% requiredRisk-free rate 4%, expected market return 9%, stock beta 1.2.
| Market risk premium | 9% − 4% = 5% |
| Expected return | 4% + 1.2 × 5% = 10% |
CAPM adds the beta-weighted risk premium to the risk-free rate to get the return investors should demand.2
Example 3 — Excess return
+2 points for the riskA strategy returns 7% while T-bills pay 5%.
| Excess return | 7% − 5% = 2 points |
Only the return above the risk-free rate rewards you for taking risk. See Sharpe Ratio.
Common risk-free proxies
| Aspect | Used for | Note |
|---|---|---|
| 3-month T-bill | Sharpe ratio, short horizons | Most common proxy |
| 10-year Treasury | Long-term valuations, DCF | Includes term premium |
| Central bank policy rate | Overnight cash | Set by policy. See Central Bank |
| Local government bills | Non-US investors | Depends on that government's credit |
Where the risk-free rate appears
Sharpe ratio
Excess return over the risk-free rate per unit of risk. See Sharpe Ratio.
CAPM and cost of equity
The starting point of required return. See Capital Asset Pricing Model.
Option pricing
An input into option models. See Option Pricing Models.
Cash as an alternative
Higher safe rates make risk assets less attractive.
Advantages and disadvantages
Advantages
- Gives a clear baseline for comparing investments.
- Easy to observe from daily Treasury data.
- Common input across finance models.
Disadvantages
- Not truly risk-free: inflation and currency risk remain.
- Choice of proxy changes results.
- Changes constantly with interest rates.
Going deeper
Read as far as you need. Each level builds on the one before it.
Where to find it
Beginner
The US Treasury publishes daily bill rates, based on closing bid quotes for recently auctioned bills, along with daily par yield curve rates.3
Nominal vs real
Intermediate
A 4% bill yield with 3% inflation leaves about a 1% real return. Treasury also publishes real yield curve rates based on inflation-protected securities.3 See Real Yield.
Why it moves markets
Advanced
Higher safe rates raise discount rates and the hurdle for risk assets, which can pressure valuations, especially for long-duration growth stocks. See Interest Rate.
Common mistakes
Mixing horizons
Using a 3-month rate to value 30-year cash flows.
Forgetting inflation
Risk-free is not purchasing-power-free.
Using a stale rate
Rates change; update your inputs.
Assuming every government is risk-free
Some governments do default.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- The risk-free rate is the return on a default-free asset.
- US Treasury bills are the usual proxy.
- It is the hurdle every risky investment must beat.
- It is a key input in CAPM, Sharpe and valuation.
- It still carries inflation and currency risk.
Frequently asked questions
What is the current risk-free rate?
Is the risk-free rate really risk-free?
What rate should non-US investors use?
Further learning
- Sharpe Ratio
Excess return per unit of risk.
- Yield Curve
Rates across maturities.
- Treasury Bills, Notes and Bonds
The usual risk-free assets.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- TreasuryDirect (U.S. Treasury). Treasury Bills (opens in a new tab) Checked .
- Corporate Finance Institute. Alpha (opens in a new tab) Checked .
- U.S. Department of the Treasury. Interest Rate Statistics (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.