Inaya Mclaughlin
Risk-free investments are considered to be reasonably certain to gain at the level predicted. While academics argue that there is no such thing as a risk-free asset, U.S. Treasurys and government debt issued by stable Western nations are considered to be risk-free for the average investor. Risk-free investments are generally associated with lower returns, as the level of risk is reflected in the rate of return.
| Characteristics | Values |
|---|---|
| Return rate | There is an anticipated return rate expected depending on the duration the asset is held |
| Risk | The unknown aspect of the future return is considered to be the risk |
| Risk-free return | The theoretical return attributed to an investment that provides a guaranteed return with zero risk |
| Risk-free rate | The interest on an investor's money that would be expected from a risk-free asset when invested over a specified period of time |
| Risk-free investments | Considered to be reasonably certain to gain at the level predicted |
| Risk-free assets | All financial assets carry some degree of danger, but the level of risk is so small that it is appropriate to consider US Treasurys or any government debt issued by a stable Western nation to be risk-free |
| Currency risk | If an investor invests in the government securities in their home country, such an investment would carry no currency risk |
What You'll Learn
Risk-free assets are subject to reinvestment risk
Risk-free assets are those that have a certain future return and virtually no possibility of dropping in value or becoming worthless. While some academics argue that there is no such thing as a risk-free asset, U.S. Treasurys and government debt issued by stable Western nations are generally considered to be risk-free. Risk-free assets are important because they serve as a foundation for all other types of investments, including the cost of equity. Since they carry no risk, all other investments, which carry some amount of risk, must offer a higher return to attract investors.
The risk-free rate represents the interest on an investor's money that would be expected from a risk-free asset when invested over a specified period of time. For example, investors commonly use the interest rate on a three-month U.S. T-bill as a proxy for the short-term risk-free rate. The risk-free return is the rate against which other returns are measured. Investors that purchase a security with some measure of risk higher than that of a risk-free asset will naturally demand a higher level of return, because of the greater chance they're taking.
While risk-free assets are considered to be reasonably certain to gain at the level predicted, the expected return and actual return may not always be the same. This is because all financial assets carry some degree of risk—the risk they will drop in value or become worthless altogether. However, the level of risk is so small that, for the average investor, it is appropriate to consider U.S. Treasurys or any government debt issued by a stable Western nation to be risk-free.
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Risk-free assets have a guaranteed return with zero risk
Risk-free assets are considered to be reasonably certain to gain at the level predicted. They have a guaranteed return with zero risk. While technically, nothing can be 100% guaranteed, the level of risk is so small that it is appropriate to consider US Treasurys or any government debt issued by a stable Western nation to be risk-free. A risk-free asset is one that has a certain future return and virtually no possibility of dropping in value or becoming worthless.
Risk-free assets tend to have low rates of return, since their safety means investors don't need to be compensated for taking a chance. Risk-free assets are guaranteed against nominal loss, but not against a loss in purchasing power. For example, investors commonly use the interest rate on a three-month US T-bill as a proxy for the short-term risk-free rate.
The risk-free return is the rate against which other returns are measured. Investors that purchase a security with some measure of risk higher than that of a risk-free asset will naturally demand a higher level of return, because of the greater chance they're taking.
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Risk-free assets have a lower rate of return
Risk-free assets are not truly risk-free, as all financial assets carry some degree of danger. However, the level of risk is so small that it is appropriate to consider them risk-free for the average investor. The risk-free rate represents the interest on an investor's money that would be expected from a risk-free asset when invested over a specified period of time. For example, investors commonly use the interest rate on a three-month U.S. T-bill as a proxy for the short-term risk-free rate.
The risk-free return is the theoretical return attributed to an investment that provides a guaranteed return with zero risk. The risk-free return is the rate against which other returns are measured. Investors that purchase a security with some measure of risk higher than that of a risk-free asset will naturally demand a higher level of return, because of the greater chance they're taking.
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Risk-free assets are not guaranteed
Risk-free assets tend to have low rates of return, since their safety means investors don't need to be compensated for taking a chance. Investors that purchase a security with some measure of risk higher than that of a risk-free asset will naturally demand a higher level of return, because of the greater chance they're taking.
Technically, academics are correct to say that there is no such thing as a risk-free asset. All financial assets carry some degree of danger—the risk they will drop in value or become worthless altogether. However, the level of risk is so small that, for the average investor, it is appropriate to consider U.S. Treasurys or any government debt issued by a stable Western nation to be risk-free. A risk-free asset is one that has a certain future return and virtually no possibility of dropping in value or becoming worthless altogether.
Risk-free return is the theoretical return attributed to an investment that provides a guaranteed return with zero risk. The risk-free rate represents the interest on an investor's money that would be expected from a risk-free asset when invested over a specified period of time. For example, investors commonly use the interest rate on a three-month U.S. T-bill as a proxy for the short-term risk-free rate.
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Risk-free assets are not subject to currency risk
Risk-free assets are considered to be reasonably certain to gain at the level predicted, with virtually no possibility of dropping in value or becoming worthless. They are guaranteed against nominal loss, but not against a loss in purchasing power. Risk-free assets tend to have low rates of return, since their safety means investors don't need to be compensated for taking a chance.
However, for the average investor, it is appropriate to consider US Treasurys or any government debt issued by a stable Western nation to be risk-free. This is because these assets have a certain future return and virtually no possibility of dropping in value or becoming worthless. Investors commonly use the interest rate on a three-month US T-bill as a proxy for the short-term risk-free rate.
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Frequently asked questions
A risk-free investment is one that has a certain future return and virtually no possibility of dropping in value or becoming worthless.
Investors invest in risk-free assets because they are reasonably certain to gain at the level predicted. The rate of return is often much lower to reflect the lower amount of risk.
U.S. Treasurys and any government debt issued by a stable Western nation are considered risk-free assets.
While risk-free assets are considered to have no risk, they may be subject to reinvestment risk over the long term. This means that the actual return and the anticipated return may be very different due to market fluctuations.
