You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.5%. Your brother-in-law, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:
Inflation premium = 3.25%
Liquidity premium = 0.6%
Maturity risk premium = 1.8%
Default risk premium = 2.15%
On the basis of these data, what is the real risk-free rate of return?
The risk-free rate is the rate of the T-bill so in this case 5.5%. The word real simply means that inflation is factored into the return. Inflation is 3.25%. So to find the real risk-free rate, simply take the 5.50% and subtract the 3.25% thus getting a 2.25% Real Risk-Free Rate.