The risk-free rate of return is the theoretical return an investor can expect from an investment that carries zero risk of financial loss — serving as the baseline against which all other investments are benchmarked. In practice, no investment is entirely risk-free, but short-term government securities are used as the closest proxy because the probability of a sovereign government defaulting on domestic currency obligations is negligible. In India, the risk-free rate is typically approximated by the yield on 91-day Treasury Bills issued by the RBI or the 10-year Government of India bond yield for longer investment horizons. The risk-free rate is a critical input in multiple financial models — it forms the base in the Capital Asset Pricing Model (CAPM) for estimating the required return on equity, the discount rate in DCF valuations, and the benchmark in the Sharpe Ratio for measuring risk-adjusted portfolio performance. When RBI raises the repo rate, the risk-free rate rises, increasing the discount rate used in valuations and putting downward pressure on equity market multiples — a key mechanism through which monetary policy affects stock prices.
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