Final answer:
The risk-free rate of return is typically associated with government bonds due to their security and low default risk. While stocks have historically provided higher average returns than bonds or savings accounts, they do so with greater risk. High risk does not inherently mean low returns, as high-risk investments can offer higher potential returns.
Step-by-step explanation:
The risk-free rate of return is normally associated with the most secure type of investment available. In financial markets, that security is often considered to be government bonds, as they have very low default risk. By contrast, investments in stocks, mutual funds, and real estate carry higher risks due to the volatility in their returns and market fluctuations.
Over time, stocks have historically provided higher average returns than bonds or savings accounts, compensating for their higher degree of risk. The fear that high-risk investments must have low returns is a misconception; high-risk investments like stocks can yield higher returns, although they can equally result in greater losses. The risk involved with such investments implies a wider range of potential outcomes rather than an assurance of low returns.
For instance, the simple interest calculation exemplifies how returns (interest) on a low-risk investment like a loan can be straightforward to compute. A $5,000 loan at a 6% simple interest rate over three years would accumulate a total interest amount of $900. Similarly, if you receive $500 in simple interest from a $10,000 loan over five years, the annual interest rate charged is 1%.