$3.$ Real Risk$-$Free Rate $($Formula Approach$)$

$1.$Quick Take: Real Risk$-$Free Rate

$2.$Learn: Real Risk$-$Free Rate

$3.$Practice: Real Risk$-$Free Rate

STEP: $1$ of $3$

Real Risk$-$Free Rate is a fundamental concept in finance.

The real risk$-$free rate of interest, r$*$r$*,$ is the interest rate that would exist on a riskless security if no inflation were expected. It may be thought of as the rate of interest on short$-$term U$.$S$.$ Treasury securities in an inflation$-$free world. The real risk$-$free rate is not static$$it changes over time, depending on the rate of return that corporations, other borrowers, and people$$s time preferences for current versus future consumption.

The real risk$-$free rate is determined as a difference between the nominal, or quoted, risk$-$free rate, rRFrRF$,$ and a premium for expected inflation, IPIP:

r$*=$rRF$$IPr$*=$rRF$$IP

The best estimate of r$*$r$*$is the rate of return on indexed Treasury bonds.

Most experts believe that r$*$r$*$fluctuates in the range of $1\%$ to $3\%.$ However, when Federal Reserve policies push interest rates on Treasury securities below the rate of expected inflation the rate on indexed Treasury bonds can be negative.

True or False: Typically, the real risk$-$free rate is less than the nominal risk$-$free rate.

True

False