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: 19 percent, –13 percent, 16 percent, 21 percent, and 10 percent. Suppose the average inflation rate over this period was 1.4 percent and the average T-bill rate over the period was 4.5 percent. a. What was the average real return on Crash-n-Burn’s stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Average real return % b. What was the average nominal risk premium on Crash-n-Burn’s stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place, e.g., 32.1.) Average nominal risk premium 6.1 %

Explanation / Answer

a. What was the average real return on Crash-n-Burn’s stock?

Just like it sounds take the average real return of the stock over the 5 years.
so (19%-13%+16%+21%+10%)/5=53 / 5 = 10.6% is the average return

To find the average real return = {(1+Average Return)/(1+Average Inflation)} -1

={(1+10.6%) / (1+ 1.4%)} -1 = (1.106 / 1.014) -1 = 1.09 - 1 = 0.09 = 9% is the average real return

b. What was the average nominal risk premium on Crash-n-Burn’s stock?

To find the average nominal risk premium we subtract average T-bill rate over the period

formula: Average nominal risk premium =  average return - average T-bill rate

= 10.6% - 4.5% = 6.1% is the nominal risk premium

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