With the ten year risk free rate, treasuries, near 2% is it realistic to assume compounding at 23% for ten or eleven years?
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That we silly people who save wouldn't know what to do with a risk free rate of return if we ever see it again.
The more conservative method is to use a Modified IRR (MIRR) where all of the cash flows are assumed reinvested at the lower risk free rate.
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When you buy a corporate bond, you buy, in essence, the risk-free rate (Treasuries) plus something extra to compensate for the risk that you won't get your money back.
Since 1926 stocks have returned approximately 10% annualized and Treasury bills (a proxy for the so-called risk-free rate) have returned 4%.
To be sure, safety-seekers who jumped into Treasury debt have been well-rewarded for their plunge into paper that pays the risk-free rate.
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Now consider this: the Federal Reserve's quantitative easing III tactic explicitly targets the "risk free interest rate" - aiming to set it at a historic low, and thus influencing all related interest rates downwards.
As per Liam Halligan in the Sunday Telegraph: there is no such thing as a "risk-free rate" set by sovereigns anymore, and you get an unsustainable hike in the bank borrowing rate in Italy which sinks the aforementioned Italian banks and then the contagion spreads to France.
And prime rate would clearly be the wrong interest rate to use for Apple cannot lend money out, risk free, at the prime rate.
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And because they have zero expected return, they are inferior to the rate of risk-free return.
Thus, the compensation for having to wait for the money should be that T-Bill rate: the available risk free return.
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Spain was unable to borrow the maximum 3.5bn euros it wished to do - and investors ended up demanding the Spanish government pay an expensive 5% interest rate for supposedly risk-free 12-month loans (Belgium too didn't sell the maximum debt on offer).
Banks generally will not lend funds in the money market at an interest rate lower than the rate they can earn risk-free at the Federal Reserve.
Whereas it can indeed, risk free, lend out money at the T-Bill rate.
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There are many other potential problems associated with municipal bonds, including interest rate risk, and although they are federally tax-free, other state and local taxes may apply and interest income may be subject to the alternative minimum tax.
That will not last for ever: if government debt continues to grow at its present rate, they may start to realise that Japanese government bonds are not the risk-free investments that they still consider them.
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