S12-05 Nominal versus Real Returns [LO2] What was the average annual return on l

Question

S12-05 Nominal versus Real Returns [LO2]

What was the average annual return on large company stock from 1926 through 2013 in nominal terms? (Round your answer to 2 decimal places. (e.g., 32.16))

What was the average annual return on large company stock from 1926 through 2013 in real terms? (Round your answer to 2 decimal places. (e.g., 32.16))

Refer to Figure 12.10. FIGURE 12.10 Historical Returns, Standard Deviations, and Frequency Distributions: 1926-2013 Standard Average Return Frequency Distribution Series Large-company stocks 12.1% 20.2% al Small-company stocks 16.9 32.3 Long-term corporate bonds 6.3 8.4 Long-term government 5.9 9.8 bonds Intermediate-term 5.4 5.7 government bonds U.S. Treasury bills 3.5 3.1 Inflation 3.0 4.1 The 1933 small-company stocks total return was 142.9 percent. SOURCE: Modified from Stocks, Bonds Bills, and inflation: 2014 Yearbook™, annually updates work by Roger G. Ibbotson and Rex A. Sinquefield Chicago All rights reserved.

Explanation / Answer

a. The nominal return = the stated return = 12.10%

b. For computing returns in real terms we will use the Fisher equation. The equation is (1+R) = (1+r)*(1+h)

or, 1+12.10% = (1+r)*(1+3%)

or 1.121 = 1+r*(1.03)

or r = 1.121/1.03 - 1

= 8.83%

Thus a = 12.10 % and b = 8.83%

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