What it is:
A risk-free return is the return from anthat has no risk (that is, it provides a guaranteed return).
How it works/Example:
Treasury bills are the most common example of risk-free assets, and their returns are thus risk-free. Accordingly, these returns are considered the money to the government (via the purchase of Treasurys) not receive their interest and principal payments when due.
Why it matters:
The notion of a risk-free return is a fundamental component of the debt, for example. But that risk is considered so minute as to be virtually zero.
Regardless of the debate over the true statistical probability of default on risk-free assets, it's important to that the risk-free return is subject to inflation risk, whereby the returns are eaten away by over time. Also, risk-free returns carry interest-rate risk, meaning that when interest rates rise, the prices of risk-free (such as Treasurys) fall, and vice versa.