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Risk-free Rate Of Return

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The return an investor can expect to receive on a totally risk-free asset is referred to as as risk-free rate of return. The risk-free rate of return exists in theory but not in practice because every investment involves some element of risk. The yield on three-month US Treasury Bills is often used as a proxy for the risk-free rate of return since treasury bills are generally considered the least risky investment. The risk-free rate of return plays an important role in modern portfolio theory which argues that the risk-free rate of return is the minimum return investors will accept on their investment. As compensation for higher risk, investors demand the risk-free rate of return plus a premium on riskier assets.



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