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Modern portfolio theory postulates the existence of at least one risky asset and one risk-free asset, usually taken to be Treasury bills or comparable short-term sovereign debt. The risk-free rate is the rate of return on the risk-free asset. This risk-free rate is lower than the expected return on the risky asset, because any issuer will have to offer a risk-averse investor the expectation of a higher return to induce him to abandon the risk-free asset for an investment with uncertain returns or, say, credit risk.
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