Risk-free rate
The risk-free rate is the baseline in CAPM and other valuation models. In practice, analysts use an appropriate government-security yield or another suitable proxy rather than a literally riskless real-world asset. Currency and time horizon matter, and a nominally secure payment can still lose purchasing power through inflation. Rates change over time. A modelled risk-free asset has zero beta with respect to the relevant market, but this does not make its expected return zero. The proxy and assumptions should be consistent with the cash flows being valued.
Worked example
With CAPM risk-free rate 3% and beta zero, required return is 3% + 0 × market premium = 3%. A $100 nominal repayment can still buy less in a year if prices have risen.
Common mistake
Equating zero beta with zero return, or assuming government debt has no possible credit, currency or inflation exposure in every context.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Direct | September 2026–June 2027 |
| ACCA | FM | Direct | September 2026–June 2027 |