Final answer:
The risk-free rate of return is the real rate plus the inflation premium. It represents the return on an investment with no risk of financial loss, and does not include a risk premium associated with riskier investments like bonds, which can have default and interest rate risks.
Step-by-step explanation:
The risk-free rate of return is synonymous with the theoretical return of an investment with no risk of financial loss. The student asked which answer choice correctly represents the risk-free rate of return. The correct answer is that the risk-free rate of return is equal to the real rate plus the inflation premium, which is the third option. This rate is considered the sum of the real rate of return, which is the return adjusted for the impact of inflation on the purchasing power of the money invested, and the inflation premium, which is the expected rate of inflation over the time horizon of the investment.
Bonds, as one of the examples of investments, indeed carry various types of risk, such as default risk and interest rate risk, and therefore offer different rates of return based on the borrower's riskiness. However, risk-free assets are considered to be free of these risks, hence the return only reflects the real rate of return adjusted for inflation.