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    Question

    Which of the following best describes the interest on

    government bonds?
    A Risk premium Correct Answer Incorrect Answer
    B Market rate of return Correct Answer Incorrect Answer
    C Market price Correct Answer Incorrect Answer
    D Risk-free rate Correct Answer Incorrect Answer
    E Beta Correct Answer Incorrect Answer

    Solution

    • The risk-free rate is the theoretical return on an investment that carries zero risk of default. • In practice, no investment is entirely risk-free, but government bonds (especially those of stable governments) are considered the closest proxy since they are backed by sovereign authority and the likelihood of default is negligible. • Hence, the interest on government bonds is generally treated as the risk-free rate in models like CAPM (Capital Asset Pricing Model).

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