From the course: Finance Foundations

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Risk-free rate

Risk-free rate

From the course: Finance Foundations

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Risk-free rate

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We'll get back to beta in just a moment, but let's spend a minute talking about the risk-free rate, which is another important element in the capital asset pricing model. Let's imagine that I've been asked to loan one dollar to the most trustworthy organization on Earth. I don't know who that is, but let's just imagine them, the most trustworthy organization on Earth. They are going to pay me back for sure. Now, what interest rate would I charge on this loan to the most trustworthy organization? That's the risk-free loan we're talking about. Well, the interest rate is not going to be zero for a couple of reasons. First of all, there might be some expected inflation. Price levels might be expected to go up; two, three, four, five percent over the next year. So I have to build at least the expected inflation rate into the interest rate that I'm going to charge. In addition, there is the time value of money. Now let me explain this by referencing the time value of candy. I can illustrate…

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