The risk-free rate is the theoretical return on an investment with no risk of loss, used as the baseline for pricing all other assets. In practice it is taken from the yield on a high-quality government bond, such as the 10-year US Treasury. It is the starting point of the CAPM formula.
Worked example
If the 10-year US Treasury yields 4.2%, an analyst will typically use 4.2% as the risk-free rate when estimating a US company's cost of equity.
Why it matters
Because it anchors both the cost of equity and the cost of debt, the risk-free rate flows into almost every valuation. When government bond yields rise, discount rates rise and asset valuations tend to fall.
Frequently asked questions
Match the maturity to your time horizon and the currency to the cash flows: a long-term valuation usually uses a 10-year government bond in the relevant currency.