What is a risk-free rate?

The risk-free rate represents the theoretical return on investment that is assumed to have no risk of financial loss. It is primarily associated with government treasury yields, particularly from stable governments, as they are seen as a safe investment due to the low likelihood of default. This rate serves as a benchmark for evaluating the performance of riskier assets, as it reflects the minimum return an investor would expect for taking on additional risk.

Typically, the risk-free rate is calculated based on the yield of long-term government bonds, such as U.S. Treasury bonds, which are considered to carry virtually no risk of default and are backed by the full faith of the issuing government. This makes option B the most accurate description of a risk-free rate.

Other options, such as the average return on high-risk investments, market volatility measures, or returns in bull markets, do not accurately capture the essence of a risk-free investment and thus do not reflect the definition of the risk-free rate.