Risk-Free Rate

 

he risk-free rate is a theoretical interest rate at which an investment may earn interest without incurring any risk. The notion is used extensively in option pricing theory where derivatives are valued with a risk neutral assumption under which all assets may be assumed to have expected returns equal to the risk-free rate. The notion of a risk-free rate is also used in Modern Portfolio Theory.

In practice, the risk-free rate is often assumed to be a short-term Treasury rate.