The risk-free rate of return is the theoretical [rate of return) ) rate represents the interest an investor would expect from an absolutely risk-free investment over a specified period of time.
The so-called “real” risk-free rate can be calculated by subtracting the current inflation rate from the yield of the Treasury bond matching your investment duration.
In theory, the risk-free rate is the minimum return an investor expects for any investment because they will not accept additional risk unless the potential rate of return is greater than the risk-free rate. Determination of a proxy for the risk-free rate of return for a given situation must consider the investor’s home market, while [negative interest ratescan complicate the issue.
The three-month U.S. Treasury bill is a useful proxy because the market considers there to be virtually no chance of the U.S. government defaulting on its obligations. The large size and deep liquidity of the market contribute to the perception of safety. However, a foreign investor whose assets are not denominated in dollars incurs [currency risk when investing in U.S. Treasury bills. The risk can be hedged via [currency forwardsand options but affects the rate of return.
The short-term government bills of other highly rated countries, such as Germany and Switzerland, offer a risk-free rate proxy for investors with assets in [euros]
(EUR) or Swiss francs ([CHF]). Investors based in less highly rated countries that are within the [eurozone], such as Portugal and Greece, are able to invest in German bonds without incurring currency risk. By contrast, an investor with assets in Russian rubles cannot invest in a highly rated [government bond) without incurring currency risk.