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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

    тАв The risk-free rate is the theoretical return on an investment that carries zero risk of default. тАв 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. тАв 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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