The risk-free rate as used in the Capital Asset Pricing Model and other investment analyses is approximated by the return on very short-term U.S. Treasury Bills. Securities issued by the U.S. Government are assumed to be free of default risk; and very short-term securities are assumed to be free of interest rate risk.
A diversified portfolio can minimize risk. However, a diversified portfolio is not a risk-free portfolio. Risk cannot be completely eliminated by diversifying the holdings in an investment portfolio. The portfolio will still be subject to systematic risk, which is risk that cannot be diversified away because it is caused by factors that affect all assets and thus the market in general. Examples of systematic risk are inflation, macroeconomic instability such as recessions, major political upheavals and wars.
High-grade commercial paper is marketable, unsecured short-term debt that is issued by large, financially sound companies with solid credit histories and high credit ratings. However, it is not risk-free, as its repayment is dependent upon the ability of the company to repay the debt.
The U.S. Federal Deposit Insurance Corporation insures deposits in member banks. An FDIC-insured savings account is a very safe account because of the FDIC insurance. However, there is no single FDIC-insured savings rate, so banks pay different rates of interest to their savings depositors. Since there is no single FDIC-insured savings rate, there is no rate among the rates paid by banks that could serve as the risk-free rate of interest.
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