The following section provides a background to the basic discount rate components. Understanding the basic discount rate elements is necessary before the models that develop the rates themselves can be examined.
A basic concept in economics is that people prefer to consume today rather than later. For people to be induced to forego consumption today, they must have a sufficiently strong incentive. In the absence of any risk, this incentive is the rate of return at which the marginal investor is prepared to invest in deferred consumption.
The proxy for this in the marketplace is the real risk-free rate of return. Australian Commonwealth Government securities are the closest approximation of a risk-free investment available.