What is the risk-free rate?
The risk-free rate is the return you can earn on the safest available asset over a given period, with practically no chance of losing your money in that currency.
In practice, analysts use the yield on short-term government debt as the risk-free rate. These are Treasury bills issued by the government in its own currency. In theory, the government can always repay debt in its own currency.
Formal definition: the risk-free rate is the return on an asset with no default risk and no reinvestment risk over the chosen horizon. It is the starting point for pricing other assets. Any asset with more risk should offer more than this rate. That extra return is the risk premium.
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Risk-free rate in Pakistan
There is no single official "risk-free rate" figure. In Pakistan, people usually use one of these:
- Market Treasury Bill yields. These are short-term government securities in rupees. They are the most common choice.
- The SBP policy rate. This is the State Bank of Pakistan's benchmark rate. The latest decision on record is: SBP policy rate raised by 50 bps to 12% with effect from 27.10.2026 (MPC). Short-term government yields tend to move with this rate. They are not identical to it.
Choose the maturity that matches your horizon. For a short holding period, use a short-dated bill. For a long-term valuation, use a longer government bond.
Worked example (hypothetical)
Say you want to judge a trading or investment result. You compare it with the risk-free rate for the same period.
| Item | Symbol |
|---|---|
| Return of your portfolio over the period | Rp |
| T-bill yield over the same period | Rf |
| Excess return | Rp − Rf |
| Sharpe ratio | (Rp − Rf) ÷ standard deviation of returns |
If Rp is below Rf, you took on risk and earned less than a government bill would have paid. The risk was not rewarded. Use the calculators to work through return figures with your own inputs.
In the CAPM model, the expected return is Rf + beta × (market return − Rf). See beta and alpha.
Where you will see the term
- News and central bank statements: policy rate decisions, often given in basis points.
- Fund reports: Sharpe ratio, alpha and annualized return all use a risk-free benchmark.
- Forex pricing: forward points and covered interest parity come from the interest rate gap between two currencies. Overnight swap fees on leveraged positions are linked to the same gap.
- Bond analysis: a credit spread is the yield above the government rate.
Edge cases experienced readers should know
- Nothing is fully risk-free. Government bills still carry inflation risk. Your real return is roughly the nominal yield minus inflation.
- Currency matters. A rupee T-bill is "risk-free" only for a rupee investor. For a dollar-based investor, it also carries currency risk.
- Foreign-currency sovereign debt can default. That is why it is not treated as risk-free.
- Rates can be negative. Some economies have had government yields below zero.
- Flight to quality: in market stress, demand for government debt can push its yields down sharply. See flight to quality.
A positive risk-free rate does not mean a leveraged trade will beat it. Leveraged CFD and forex trading can lose money fast, including more than the expected gain.
Related terms
Coupon (bond) · Bond duration · Fundamental analysis · Saving, Investing, Loans · Trading glossary
Frequent questions
What is the risk-free rate meaning in simple words?
It is the return you get from the safest asset, usually a short-term government bill, with almost no risk of losing your money.
What is the risk-free rate in Pakistan?
Most analysts use the yield on rupee Market Treasury Bills. Some use the SBP policy rate as a quick reference. Check the current figure on the State Bank of Pakistan's official site.
Is the policy rate the same as the risk-free rate?
No. The policy rate is the central bank's benchmark. T-bill yields usually stay close to it but are set in auctions and in the market.
Why does it matter for traders?
Many performance measures subtract it from returns. Interest rate gaps between currencies also affect forward prices and overnight swaps.