An Analysis of the Risk-Free Rate in the South African Capital Market - Dissertation Example

South Africa is an emerging country that has developed a deep Capital Market in the short span of time since its independence (Wajid et al, 2008). Capital Markets play a crucial role in the overall development of the economy as these provide the basic resources for large infrastructure and nation-building projects, and hence, these are essential for any countries’ long-term growth and progress. In the last decade, South Africa has made several structural as well as institutional changes to consolidate the capital market in the country.

These changes involved the consolidation of the government bonds into benchmark bonds and the development of the secondary bond market and the establishment of BESA or the Bond Exchange of South Africa. The conducive market environment led to increased participation from the private sector and there was an influx of corporate bonds. The introduction of private bonds in the market was paralleled by the increased involvement of the private sector in the utilities and infrastructure sector of South Africa.

With the introduction of liberalization and the opening up of the market, there was an increase in foreign investments in South Africa. As a result, of the increasing reforms and the growth in the South African economy, more and more foreign investors participate in trading on the Johannesburg Stock Exchange (JSE). Now, foreign investors are responsible for the majority of the activity represented in the South African Markets. The London Stock Exchange (LSE) and New York Stock Exchange (NYSE) contribute to more than 70% of the activity on the JSE.

While this is good for the economic development and prosperity of South Africa, there are some inhibitions about how the risk-free rate of South Africa should be assessed. This is because, in a closed environment, as in the case when there are no foreign players, the risk-free rate is determined by the government securities that are held as completely free of risk including default risk.