Risk free rate

The risk free rate of return is the best rate that does not involve taking a risk. Both the return of the original capital and the payment of interest are completely certain.

The risk free rate for a given period is taken to be the rate on government bonds over the period. This is because a government cannot run out of its own currency, as it is able to create more as necessary.

Any other investment should produce greater returns than the risk free rate. The extra return (the risk premium) reflects the extra risk involved.

The risk free rate is used by the CAPM and other valuation models.