so is the fu- ture price of indexed bonds. Nevertheless, it is common practice to view Treasury bills as "the" risk-free asset. Their short-term nature makes their values insensitive to interest rate fluctuations. Indeed, an investor can lock in a short-term nominal return by buying a bill and holding it to matu- rity. Moreover, inflation uncertainty over the course of a few weeks, or even months, is negligible compared with the uncertainty of stock market returns. In practice, most investors use a broader range of money market instruments as a risk- free asset. All the money market instruments are virtually free of interest rate risk because of their short maturities and are fairly safe in terms of default or credit risk. Most money market funds hold, for the most part, three types of securities-Treasury bills, bank certificates of deposit (CDs), and commercial paper (CP)-differing slightly in their default risk. The yields to maturity on CDs and CP for identical maturity, for exam- ple, are always somewhat higher than those of T-bills. The pattern of this yield spread for 90-day CDs is shown in Figure 7.1. Money market funds have changed their relative holdings of these securities over time but, by and large, T-bills make up only about 15% of their portfolios. Nevertheless, the risk of such blue-chip short-term investments as CDs and CP is minuscule compared with that of most other assets such as long-term corporate bonds, common stocks, or real estate. Hence we treat money market funds as the most easily accessible risk-free asset for most investors.     7.3 PORTFOLIOS OF ONE RISKY ASSET AND ONE RISK-FREE ASSET   In this section we examine the risk-return combinations available to investors. This is the "technological" part of asset allocation; it deals only with the opportunities available to in- II. Portfolio Theory 7. Capital Allocation between the Risky Asset and the Risk−Free Asset The McGraw−Hill Companies, 2001         CHAPTER 7 Capital Allocation between the Risky Asset and the Risk-Free Asset 187     Figure 7.1 Spread between three-month CD and T-bill rates.     5.0   4.5