Risk-free bond

A risk-free bond is a theoretical bond that repays interest and principal with absolute certainty. The rate of return would be the risk-free interest rate. In practice, government bonds are treated as risk-free bonds, as governments can raise taxes or indeed print money to repay their domestic currency debt.[1]

For instance, United States Treasury notes and United States Treasury bonds are often assumed to be risk-free bonds.[2] Even though investors in United States Treasury securities do in fact face a small amount of credit risk,[3] this risk is often considered to be negligible. An example of this credit risk was shown by Russia, which defaulted on its domestic debt during the 1998 Russian financial crisis.

Application

When hedging according to formulas like Black–Scholes, a risk-free bond would be priced accordingly.

See also

References

  1. ↑ "Belgium’s KBC scraps ‘risk-free’ practice on sovereign bonds - FT.com".
  2. ↑ "Risk-Free Asset". Investopedia. investopedia.com. Retrieved 1 March 2016.
  3. ↑ Mattia, Laura (February 25, 2014). "Think Bonds Are Risk-Free? Think Again.". abcnews.go.com. ABC. Retrieved 1 March 2016.
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