What is risk free rate?

Risk free rate in theory is the minimum return that an investor expects from any investment without accepting any risk. A rational investor doesn’t accept any additional Risk unless he/she expects greater return than risk free rate. Risk free rate doesn’t exist in practice because even the safest investment carries a small amount of risk. However, a three -month U.S. Treasury bill is usually used as the risk free rate.

Risk free rate in Iran

Issuing bond for financing is forbidden according to the Iran’s Islamic Banking regulation therefore one of the most important points that we should consider for analyzing risk free rate in Iran is banking regulation. So, bank deposit interest rate and Mosharekat Sukuk had been used as a benchmark for risk free rate until issuing treasury bills in September 2015. Interest on these three types of investment use as a benchmark for risk free rate.

Interest rate on Bank deposit and mosharekat Sukuk

After Iran’s Islamic revolution, bank deposit interest rate had been used as risk free rate until Mosharakat Sukuk issued by government. Inflation and government economic policies affect mentioned interest rates extremely. The return on One-year bank deposit is 20 percent at the moment.

Mosharekat Sukukis a kind of Sukuk that is being issued by government, municipality and governmental and private companies for financing infrastructure, production and service projects. Central bank of Islamic republic of Iran (CBI) is responsible for providing regulation for Sukuk. The amount of Sukuk owner’s share are written on the mosharekat Sukuk papar. The main difference between Mosharekat Sukuk and bond is in the way for spending gathered funds. Gathered funds in Mosharekat Sukuk should be spent in predetermined projects but it doesn’t work for bonds. Mosharekat Sukuk published in 1994 for the first time. The return of Sukuk is now 22 percent on average.

Inflation, Bank deposit interest rate and Mosharekat Sukuk rate are shown in the following table as a comparison.

year Intrest rate Inflation Sukuk Interest rate year Intrest rate Inflation Sukuk Interest rate
1994 14.5% 35.2% NA 2005 14.5% 10.4% 18.0%
1995 14.5% 49.4%  NA 2006 15.0% 11.9% 18.0%
1996 14.5% 23.2%  NA 2007 17.0% 18.4% 17.0%
1997 14.0% 17.3%  NA 2008 15.5% 25.4% 17.0%
1998 14.0% 18.1%  NA 2009 15% 10.8% 16.0%
1999 14.0% 20.1%  NA 2010 14% 12.4% 16.0%
2000 14.0% 12.6% 17.0% 2011 17% 21.5% 18.0%
2001 13.0% 11.4% 15.0% 2012 17% 30.5% 21.0%
2002 13.0% 15.8% 17.0% 2013 20% 34.7% 22.0%
2003 13.0% 15.6% 17.0% 2014 23% 15.6% 22.0%
2004 13.0% 15.2% 17.0% 2015 20% 10.2% 22.0%

 

Treasury Bill

Islamic Treasury bill is a kind of debt security which has issued in September 2015 for the first time. It’s a zero coupon security with 1,000,000 Rials nominal value. Total value of mentioned security is 10,000 billion Rials at the first issuing. The main objective of issuing treasury bills in Iran is settling government’s debt to contractors. The government plans to issue more treasury bill with different maturity dates considering 320,000 billion Rials government debt, it is estimated this market going to be deeper and more efficient. The return on issued Treasury bill with maturity in March 2016 is 26 percent return at the moment.

According to inflation rate recent decrease from 15 percent to 10 percent and decrease in interbank offered rate from 31 percent to 19 percent in Iran, it is estimated that risk free rate will decrease soon. This is a great opportunity for foreign investors considering real inflation and risk free rate in Western countries and even depreciation of Rial which we don’t expect to be more than 10% annually.