You’ve observed the following returns on Crash-n-Burn Computer’s stock over the

Question

You’ve observed the following returns on Crash-n-Burn Computer’s stock over the past five years: 16 percent, –5 percent, 19 percent, 13 percent, and 10 percent. Suppose the average inflation rate over this period was 2.2 percent and the average T-bill rate over the period was 5.3 percent. What was the average real risk-free rate over this time period? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Average real risk-free rate ? What was the average real risk premium? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Average real risk premium ?

Explanation / Answer

Average real risk free rate using the fisher equation,

(1 + R) = (1 + r)(1 + h)
= (1.053 / 1.022) - 1
= .0303, or 3.03%

Average return on stock – (16% -5% + 19% + 13% + 10%)/ 5 = 10.6%

Average real return on stock using fisher equation,

(1 + R) = (1 + r)(1 + h)
= (1.106 / 1.022) - 1
= .0822, or 8.22%

Average real risk premium = Average real return - Average risk-free rate

= 8.22% - 3.03%
= 5.19%

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