How is the risk-free rate defined?

The risk-free rate is defined as the return on an investment that carries no risk of financial loss, and it is typically represented by the returns on government bonds, such as U.S. Treasury bills. This benchmark is considered "risk-free" because it is backed by the government, which is unlikely to default on its obligations. The risk-free rate serves as a foundational concept in finance, particularly in the assessment of investment performance and in the determination of the cost of capital. Investors use this rate to gauge the return expected from investments that do carry risk, setting a baseline return that compensates for the absence of risk.

The other options do not accurately capture the essence of the risk-free rate. For instance, the average return on high-risk investments does not represent a guaranteed return and is not devoid of risk. The rate of return necessary to encourage investment is a more subjective measure that depends on multiple factors, including market conditions and individual risk tolerance. Similarly, the return on investments in established companies implies a risk that does not align with the concept of a risk-free return, as these investments can still fluctuate based on market performance. Thus, the definition provided in the correct answer focuses specifically on the concept of risk-free investing, making it the most accurate choice.