The risk-free rate refers to the yield on high-quality government bonds. The number of models and theories based on this concept conveys its importance in finance. They include the risk premium and models such as the capital asset pricing model. Like most models, it is based on a number of assumptions. Theoretically the risk for the investor should be zero. Below I will discuss the risk-free rate and its importance on finance (Damodaran, 2010). The most common risk-free interest rate is the short-term U.S. Treasury bond and is seen as a proxy. It is therefore assessed as the entity at risk of default. They are considered the most liquid bonds on the market (Buttonwood, 2014). It is considered easy to obtain and therefore most efforts are focused on estimating risk parameters of individual companies and risk premiums based on it (Damodaran, 2011). The risk-free rate of return is key to measuring present value. It recognizes that cash today is not the same as it will be in the future. If invested, we should expect the time value of money to remain the same. These are key elements in the financial world and important indicators for investors. The measurement of risk is the main reason for the concept of the risk-free rate and its importance for the theory of finance. All investments are made with the expectation that returns will be realized over the life of the asset. The risk-free rate comes into effect when the actual and expected rates of return differ. The concept of risklessness is that actual returns equal expected returns. An investment is risk-free when there is no variation around the return (Damodaran, 2014). This introduces the concept of risk premium. The risk premium is calculated by subtracting the riskiest return from the risk-free rate. T...... middle of paper ...... a flaw in the financial system. Many critics have argued that the 2008 economic crash exposed weaknesses in traditional financial models, including the risk-free rate. As a traditional cost of equity input there has been a significant decline in yields on risk-free government bonds. At the time, many central banks launched a large portion of medium- and long-term bonds, which some believe is the cause of the lower yields (Grabowski, 2014). There is nothing that is truly risk-free. Stocks are always risky because the future is unknown and all stocks have a measure of risk. But as we can see with most return models, the risk-free rate is extremely important. Can this problem be solved if the risk-free rate receives a new definition? Should it be the lowest rate risk with return? Fisher argues that many investors consider the risk-free rate to be a good enough measure (Fischer, 2014).