Definition of Risk-Free Rate
The risk-free rate is the theoretical return on an investment with zero risk — i.e., an investment where you are certain to get your money back with the promised return and no chance of default. In practice, it is represented by government-backed instruments like Treasury Bills (T-bills) or Government Securities (G-Secs).
In India, the 91-day Treasury Bill yield (currently around 6.5–7%) or the 10-year Government Bond yield is commonly used as the risk-free rate for financial calculations. The risk-free rate is the baseline — any investment should offer a return above this rate to justify the additional risk taken.
The risk-free rate is used in several important financial calculations: CAPM (Capital Asset Pricing Model) for pricing expected returns, Sharpe Ratio (excess return over risk-free rate per unit of risk), and as the minimum acceptable return when evaluating any investment opportunity. During high inflation periods, the real risk-free rate (nominal rate minus inflation) can be negative, which actually makes equity investing even more critical for wealth preservation.