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: 12 percent, –9 percent, 20 percent, 17 percent, and 10 percent. Suppose the average inflation rate over this period was 3.2 percent and the average T-bill rate over the period was 4.9 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))

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

Explanation / Answer

Average real Risk Free Rate ("RFR")...using:
(1+ real rate)(1+ inflation rate) = (1 + nominal rate)
rearranged:
(1+nominal rate) / (1 + inflation rate) = (1 + real rate)
...1.043 / 1.0328 = 1.00988...subtract 1 = 0.00988 average real rate, convert to % = 0.988%

geometric mean return:
(1 + -0.264)(1.146)(1.322)(1.028)(1.218) = 1.39616^1/5 - 1 = 0.06902, or, roughly 6.9%

mean real return:
(1 + nominal) / (1 + inflation) = (1 + real)
1.06902 / 1. 0328 = 1.03507 - 1 = 0.03507, or roughly 3.5%

mean real return - mean real RFR= mean real risk premium
0.03507 - 0.00988 = 0.02519, or roughly 2.5%

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