What is the Risk-Free Rate of Return?

The risk-free rate of return is the return expected from an investment that is considered to have zero risk of default. In practice, the 3-month Treasury Bill is assumed to have a risk-free rate of return. This rate of return establishes the minimum threshold for a rate of return on any investment, since an investor would logically invest in Treasury Bills rather than invest in anything else that offered a lower rate of return. However, any investment has some risk associated with it, even a 3-month Treasury Bill.

If a foreign investor is investing in Treasury bills, the associated risk-free rate could be somewhat different than the rate experienced by a United States investor, since the foreign investor also has to account for currency risk. In this situation, the investment may be impacted by fluctuations in the exchange rate.

Examples of the Risk-Free Rate of Return

Here are several examples of financial instruments that generate what investors consider to be a risk-free rate of return:

U.S. Treasury Bonds. These are considered the most common example of a risk-free rate, especially in the United States. Since the U.S. government is highly unlikely to default, the yield on U.S. Treasury bonds (T-bills, T-notes, and T-bonds) is often used as a proxy for the risk-free rate.
German Bunds. In Europe, German government bonds (Bunds) are often considered a risk-free investment, particularly in the Eurozone, due to Germany’s strong credit rating and stable economy.
Swiss Government Bonds. Switzerland is known for its financial stability, and its government bonds are often used as a benchmark for the risk-free rate, especially in the context of the Swiss Franc.
Japanese Government Bonds (JGBs). Japanese government bonds are considered risk-free investments and are often used to measure the risk-free rate in the context of the Japanese Yen.
UK Gilts. In the United Kingdom, UK government bonds, known as Gilts, are considered risk-free and are used to estimate the risk-free rate for investments in British Pounds.
Short-term bank deposit rates. In some cases, the interest rates on short-term bank deposits in highly stable and reputable banks are used as a proxy for the risk-free rate, especially in local contexts where government bonds are not as liquid or accessible.