March 26th, 2009 
Tushar Mathur
The risk-free rate of return is one of the most basic components of modern finance and many of its most famous theories. The capital asset pricing model (CAPM), modern portfolio theory (MPT) and the Black-Scholes model all use the risk-free rate as the primary component from which other valuations are derived. The risk-free asset only applies in theory, but its actual safety rarely comes into question until events fall far beyond the normal daily volatile markets.
An article by Michael Schmidt looks at the risk-free security in theory and in reality (as a government security), evaluating how truly risk free it is. The model assumes that investors are risk averse and will expect a certain rate of return for excess risk extending from the intercept, which is the risk-free rate of return. Find details…
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