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What is the Risk-Free Rate of Return?
By Bajaj Broking Team
2 September 2026
5 mins read
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Summary:
The risk-free rate of return is the return on an investment with zero risk. It is a theoretical idea. It acts as a baseline for the stock market. Government bonds and T-Bills come closest to this idea in real life. This article explains what the risk-free rate means. It also covers how to calculate it and why it matters in models like CAPM and the Sharpe ratio.
At each step of your investment journey, you need to weigh risks and returns against one another and make smart decisions about buying, holding or selling your assets. You can use various metrics and concepts to understand how the risks and returns from an investment stack up against one another. One such parameter is the risk-free rate of return.
Every time you invest, you weigh risk against return. This helps you decide whether to buy, hold, or sell an asset in the stock market. The risk-free rate of return is one tool that helps with this.
It shows the return you would expect from an investment with no risk at all. This rate becomes the baseline. Every other return in the market gets compared against it.
Characteristics of the Risk-Free Rate
No investment is truly risk-free. Every asset carries some risk. Government securities come closest to this idea. They are used as a practical benchmark.
No true zero-risk asset exists: Even government bonds carry some risk. This includes inflation risk and currency risk. The risk is small for stable economies, but it is never zero.
Government securities act as the benchmark: T-Bills and bonds are seen as the closest thing to risk-free. A government default on its own currency debt is very rare.
U.S. Treasury Bills set the global standard: Markets around the world use U.S. T-Bills as a benchmark. The U.S. debt market is the most liquid in the world. It also carries very low default risk.
India uses its own bonds as a benchmark: Indian T-Bills and government bonds serve this role at home. They range from 91 days to several years in maturity.
The right benchmark depends on your time frame: Short-term T-Bills suit short-term goals. The 10-year bond rate suits long-term goals.
Importance of Risk Free Rate of Return
The risk-free rate matters a lot. Almost every other calculation in the stock market starts here. Without this baseline, comparing risk across investments would be hard.
It anchors pricing models: Models like CAPM and the Black-Scholes formula use this rate as a key input. They need it to value assets correctly.
It helps measure risk-adjusted returns: The Sharpe ratio compares an investment's return to its risk. It starts its calculation with the risk-free rate.
It shapes borrowing and lending costs: Loan rates and deposit rates often follow the risk-free rate. Banks use it as a pricing reference.
It sets a minimum bar for investors: Any riskier investment should offer more return than the risk-free rate. This extra return rewards you for taking on risk.
It reflects the wider economy: This rate moves with monetary policy, inflation, and government borrowing. (Source: RBI)
Risk-Free Investments: Do They Exist?
When you start to research the concept of the risk-free rate of return, you may wonder if there is any investment that actually carries zero risk. While this may be possible in theory, it is not true in practice because every investment carries some level of risk. Nevertheless, for the purpose of computing the real and nominal risk-free rates of return, securities issued by the government are generally considered as close to being risk free as possible.
In most parts of the world, U.S. Treasury Bills or T-bills are used as the benchmark for analysing the risk-free rate. This is because of the following reasons:
The market almost universally believes there is no chance of the U.S. government defaulting on its debts
The U.S. government debt market is the most liquid market segment in the world
If you want a more domestic benchmark to compute the risk-free rate of return in India, you can use the rates offered by the Indian government on its bonds and T-bills. These securities have maturity periods ranging from 91 days to several years. Depending on the timeframe for which you are calculating the risk-free rate of return in India, you can choose the debt security.
For example, the rate of return from Indian T-bills may be a suitable benchmark for short-term analysis. However, if you want to compute the risk-free rate of return over the long term, the 10-year bond rate offered by the Indian government may be suitable. As of 2023, this rate is a little over 7% per annum.
Nominal vs. Real Risk-Free Rate of Return
The nominal risk-free rate is the rate you see quoted. It has not been adjusted for inflation. The real risk-free rate fixes this. It shows your true gain in buying power.
Term | Definition | Formula |
Nominal Risk-Free Rate | The stated return on a government bond. Not adjusted for inflation. | As quoted on the bond or T-Bill |
Real Risk-Free Rate | The return after removing the effect of inflation. | Real Rate = Nominal Rate − Inflation Rate |
Factors Affecting the Risk-Free Rate of Return
Several factors drive movement in the risk free rate of return in India and globally. Central bank monetary policy sits at the centre, since interest rate decisions directly shape government bond yields.
Inflation expectations play a close second role. When inflation is expected to rise, bond yields typically rise too, since investors demand a higher return to compensate for reduced purchasing power.
Government borrowing levels also matter. Higher borrowing can push yields up, as the market absorbs more supply of government debt. As of June 2026, India's 10-year government bond yield sits at approximately 6.85%, reflecting these combined pressures. (Source: RBI)
Currency stability and broader economic conditions round out the picture. A stable currency and steady growth outlook tend to keep the risk free rate more predictable, while geopolitical uncertainty or capital outflows can push it in either direction depending on investor sentiment.
How to Calculate the Risk Free Rate of Return
The risk-free rate is based on government bond yields. These bonds carry almost no credit risk. This makes them a clean benchmark for return alone.
For Indian markets, you pick short-term or long-term bonds. This choice depends on your investment horizon. As of June 2026, India's 10-year government bond yield was close to 6.85% per year. (Source: RBI)
- Risk-Free Rate of Return in CAPM
The Capital Asset Pricing Model uses the risk-free rate of return to compute the expected returns from an asset. The formula used for this purpose is shown below.
| ERa = Rf + βa (ERm — Rf) |
Where,
ERa is the expected rate of return from the asset
Rf is the risk-free rate of return
βa is the beta of the asset
ERm is the expected rate of return from the market
(ERm — Rf) is the market risk premium
Let’s look at an example to understand this better. Say the risk-free rate of return is 5%, the expected rate of return from the market is 11% and the beta of an asset is 2. In that case, the rate of return you can expect from the asset (ERa) can be computed as shown below.
ERa = Rf + βa (ERm — Rf)
= 5% + 2 (11% — 5%)
= 5% + 12%
= 17% per annum
- Risk-Free Rate of Return in Sharpe Ratio
Analysts also use the risk-free rate to compute the Sharpe ratio, which compares the returns from an investment with the risk it poses for the investor. The higher the Sharpe ratio is, the better because it means you are getting higher returns for taking on additional risk.
Also Read: What Is Risk Management In Stock Market?
What Does the Risk-Free Rate of Return Tell You?
You know the meaning of the risk-free rate of return and how it is used in various asset pricing models and ratios. But what does this metric really tell you? The answer is three-fold. The risk-free rate of return reflects the following aspects:
- Rental Rate
This is the actual rate of return on your investments when you lend your funds over a given period. It is considered lending because debt instruments consider investors’ capital as a loan.
- Inflation
The nominal risk-free rate of return accounts for the inflation rate over the period of investment. This helps you compute the real returns you will earn after the effect of inflation on your money.
- Investment or Maturity Risk
Changes in interest rates and other economic factors can increase or decrease the principal value of your investment. The maturity risk is the risk of your investment corpus decreasing in value before the maturity date.
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Content Partner - Dalal Street Investment Journal Wealth Advisory Private Limited
This article is for educational purposes only and should not be considered investment advice. Market investments are subject to risks. DSIJ Wealth Advisory Private Limited is a SEBI-registered Research Analyst (Reg. No: INH000006396) and Investment Adviser (Reg. No: INA000001142). Please consult your financial adviser before investing.
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Publish Date:
02 Sep 2026
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THIRD PARTY PRODUCT DISCLAIMER
Bajaj Financial Securities Limited is a distributor for Non-Broking Products/Services such as Mutual Funds, Mutual Funds SIP, IPO, Bonds, Insurance, PMS, Global Investing, any other third-party products/services. These are not Exchange Traded Products, and we are only acting as distributors. All disputes with respect to the distribution activity, would not have access to SCORES/ODR, Exchange investor redressal forum or Arbitration mechanism. Please refer to the detailed disclaimer for Third-Party Products.
DISCLOSURE TO CLIENTS REGARDING PAYOUT OF FUNDS
As per SEBI circular no. SEBI/HO/MIRSD/MIRSD-PoD-1/P/CIR/2023/84 dated June 08, 2023, Stockbrokers are required to upstream the entire client funds lying with them to the Clearing Corporation. Based on client’s request the funds’ release request must be placed with the Clearing Corporation. Based on the internal process and cut-off timelines of the Clearing Corporation the funds will be released to the Stock Broker. In view of this new process, as specified by the regulatory and the cut-off time of Clearing Corporation/Banks processing the funds, Bajaj Financial Securities Limited cannot commit the exact time for releasing funds payout to its client. Clients are requested to note that, Bajaj Financial Securities Limited will not be responsible for any inconvenience caused to clients due to delay in release of funds payout, including fines, delayed charges, defaults, etc.