What does the term "risk-free rate" generally refer to?

The term "risk-free rate" generally refers to the yield of government securities, particularly those issued by a stable government, such as U.S. Treasury securities. These securities are considered to have minimal risk of default because they are backed by the full faith and credit of the government issuing them, making them a benchmark for evaluating returns on other investments that carry risk.

In the context of financial analysis and the capital asset pricing model (CAPM), the risk-free rate is crucial because it serves as the foundation for determining the expected returns required for taking on additional risk. Investors seek returns above the risk-free rate when choosing to invest in riskier assets, such as stocks or corporate bonds.

This understanding of the risk-free rate helps to establish a baseline return for comparison with other investment opportunities, reflecting the compensation investors expect for taking on additional risk. Thus, option B accurately captures the essence of what the risk-free rate signifies in financial markets.