Estimating a Risk-Free Rate
This section looks at how best to estimate a risk-free rate in markets where a default-free entity exists. We will also look at how risk-free rates in nominal terms can be different from real risk-free rates, and why risk-free rates can vary across currencies.
Requirements for an Investment to Be Risk-Free
If we define a risk-free investment as one where we know the expected return with certainty, under what conditions will the actual return on an investment always be equal to the expected return? In general, two basic conditions must be met:
The first is that there can be no default risk. Essentially, this rules out any security issued by a private entity, since even the largest and safest firms have some measure ...