Economics Time Value Of Money Questions
The risk-free rate refers to the theoretical rate of return on an investment with zero risk. It is typically based on the yield of a government bond or a similar low-risk investment.
In the context of the time value of money, the risk-free rate is used as a benchmark to determine the present value of future cash flows. It represents the minimum rate of return an investor would require to compensate for the time value of money and the risk associated with an investment.
When calculating the present value of future cash flows, the risk-free rate is used as the discount rate. This discount rate reflects the opportunity cost of investing in a risk-free asset instead of a potentially higher-risk investment. By discounting future cash flows at the risk-free rate, the time value of money is taken into account, as it recognizes that a dollar received in the future is worth less than a dollar received today.