Certified Financial Management Specialist Practice Exam

What economic condition is often associated with a high real risk-free rate?

1. High inflation expectations

2. Strong economic growth

3. Stagnant economic conditions

4. High unemployment levels

The correct answer is: Strong economic growth

A high real risk-free rate typically signifies a strong economic growth environment. This situation indicates that investors anticipate a robust return on their investments due to an expanding economy. In such conditions, the demand for capital increases as businesses seek to invest in growth opportunities. Consequently, this leads to competition for available funds, driving up interest rates, including the real risk-free rate. In contrast, high inflation expectations, stagnant economic conditions, and high unemployment levels usually exert downward pressure on the real risk-free rate. High inflation tends to erode the value of returns, leading to a lower appetite for risk. Stagnant economic conditions often indicate a lack of opportunities for investment, which can lead to lower interest rates. High unemployment levels suggest sluggish economic activity, further reducing the likelihood of a high real risk-free rate as businesses are less inclined to borrow and invest. Thus, strong economic growth is the condition most closely associated with a high real risk-free rate.