Certified Financial Management Specialist Practice Exam

Which rate includes an inflation premium on risk-free assets?

1. Real Risk-Free Rate (R*)

2. Nominal Risk-Free Rate

3. Liquidity Premium (LP)

4. Maturity Rate Premium

The correct answer is: Nominal Risk-Free Rate

The nominal risk-free rate is the correct answer because it is defined as the interest rate that investors expect to receive on a risk-free asset, such as government bonds, without taking inflation into account. This rate reflects the total returns investors seek, encompassing both the underlying real return and the inflation premium. In contrast, the real risk-free rate is the rate that would exist on a risk-free asset if there were no expected inflation. Therefore, it does not include an inflation premium. The liquidity premium pertains to the compensation investors require for holding less liquid investments, rather than for inflation risk. Similarly, the maturity risk premium compensates investors for the risk associated with the length of time until an investment matures, which again does not directly relate to inflation. Thus, the nominal risk-free rate is the rate that incorporates inflation expectations, aligning with its definition as a comprehensive rate that reflects the total return necessary to maintain purchasing power in an inflationary environment.