According to the CAPM model, Expected Return = Risk free rate + Risk premium. Here, what does the risk free rate compensate the investor for?
The CAPM compensates investors for the time value of their money. In theory, the risk free interest rate is the minimum return an investor expects for any investment because he will not accept additional risk unless the potential rate of return is greater than the risk-free rate. In practice, risk free rate does not exist because even the safest investments carry a very small amount of risk. However, the long term G-sec rate is used as a proxy to risk-free rate of return (in India 10 year G-sec rate is used as risk free rate).
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