A risk-free bond is a theoretical bond that repays interest and principal with absolute certainty. The rate of return would be the risk-free interest rate. In practice, government bonds are treated as risk-free bonds, as governments can raise taxes or indeed print money to repay their domestic currency debt.
For instance, United States Treasury notes and United States Treasury bonds are considered risk-free bonds, even though investors in United States Treasury securities do face a negligible amount of credit risk. An example of this credit risk was shown by Russia, which defaulted on its domestic debt in 1998.
When hedging according to formulas like Black–Scholes a risk-free bond would be purchased (or sold) accordingly.
- ^ "Belgium’s KBC scraps ‘risk-free’ practice on sovereign bonds - FT.com".