Risk-free rate of return in an economy is the return offered on U.S. Treasury bills. These are considered risk-free based on the idea that the U.S. government has no risk on its debt obligations. The explicit rate can be directly inferred from the yield offered on these securities. Another way to calculate the risk-free rate of return is suggested by the Capital Asset Pricing Model (CAPM). The CAPM requires market return, market risk premium, required rate of return and beta as inputs for the estimation of the risk-free rate.

Market Return

The market return is the return on the chosen index, while the risk premium is the difference between the market return and the risk free rate. The beta measures the sensitivity of stock returns relative to the market and is higher than one if the stock is more volatile compared to the market.

Calculating Risk-free Return From Efficient Frontier

Step 1

Calculate the annual market return by subtracting the current value of the market index from the beginning value of the market index and divide by the beginning value of the market index.

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