risk-free security

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A security which is free of the various possible sources of risk. One is the risk that the debtor may default; this is thought to be absent in the case of UK, US, and many other countries' government debt. A second risk is that the market price may be low at the time when a security has to be sold; this risk is high for securities with a long time to maturity, and shrinks steadily as the maturity date gets closer. In money terms, a government obligation is risk-free if the holder has the option to have it redeemed at any time. In real terms, so long as there is uncertainty about inflation no security is risk-free, unless it is suitably indexed. From any individual's point of view, the suitable index would have weights corresponding to his or her own tastes, and be kept fully up to date. Actual UK government indexed securities use the retail price index with a lag of several months, so are not entirely risk-free in real terms. A third source of risk derives from currency fluctuations. US treasury bills are usually seen as the closest practical equivalent to a risk-free security, provided that the holder ultimately wishes to purchase commodities denominated in dollars.

Subjects: Economics.

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