S12-11 Calculating Real Rates [LO1] You’ve observed the following returns on Cra

Question

S12-11 Calculating Real Rates [LO1]

You’ve observed the following returns on Crash-n-Burn Computer’s stock over the past five years: 14 percent, –9 percent, 16 percent, 21 percent, and 3 percent. Suppose the average inflation rate over this period was 3.5 percent and the average T-bill rate over the period was 4.2 percent.

What was the average real risk-free rate over this time period? (Round your answer to 2 decimal places. (e.g., 32.16))

What was the average real risk premium? (Round your answer to 2 decimal places. (e.g., 32.16))

You’ve observed the following returns on Crash-n-Burn Computer’s stock over the past five years: 14 percent, –9 percent, 16 percent, 21 percent, and 3 percent. Suppose the average inflation rate over this period was 3.5 percent and the average T-bill rate over the period was 4.2 percent.

Explanation / Answer

To find the average return, we sum all the returns and divide by the number of returns,so:

Average return = (0.14 – 0.09 + 0.16 + 0.21 + 0.03)/5 = 0.09, or 9%

To calculate the average real return, we can use the average return of the asset, and theaverage inflation in the Fisher equation. Doing so, we find:

(1 + R) = (1 + r)(1 + h)= (1.090/1.035) – 1 = 0.0531, or 5.31%

b.The average risk premium is simply the average return of the asset, minus the average risk-free rate, so, the average risk premium for this asset would be:

= 9%-4.2%

=4.8%

Thanks

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