Risk Free Rate! How much can you make without risking a rupee?

What if I say as an investor you can always beat inflation and also generate returns on your investment without adding any risk in to your portfolio. Seems like a fairy tail right? Risk Free Rate is one of the most important basic concepts of finance for an investor to keep on mind.

It simply is the rate of returns an investor can generate without taking any risk and such investment opportunities are provided by Government bonds, KVP (Kisan Vikas Patra), National Savings Scheme and Bank Fixed Deposits. These are some of the investment opportunity which has no risk and provides returns sufficient to beat inflation.

The Risk free rate in India for one year can be assumed to be 6.9% since the return on 1 year Bank Fixed Deposit is the same.

Risk free rate is also considered as an opportunity cost while making any investment decisions as investors can generate at least the Risk Free Rate returns.

Investors Perspective

As an investor Risk Free Rate plays a crucial role in making investment decisions as investing in equity involves risk investors should always look for a risk-premium over investments done in equity. an example will make it easier to understand.

Ex: Mukesh is an Indian investor looking forward to invest Rs.100,000/- into a company ABC Ltd. The value of Mukesh's investment is expected to be Rs.1,06,800/-. Since the return on the investment is equal to the risk free rate the opportunity is not worth investing as Risk premium is absent.