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: 3 percent, -10 percent, 26 percent, 13 percent, and 17 percent. The average inflation rate over this period was 3.4 percent and the average T-bill rate was 4.85 percent. Requirement 1: What was the average real return on Crash-n-Burn’s stock? (Do not round intermediate calculations.) Requirement 2: What was the average nominal risk premium on Crash-n-Burn’s stock? (Do not round intermediate calculations.)

Explanation / Answer

Solution:

1.

2.

Average nominal risk premimum = Nominal averag return - Risk free retun

Average nominal risk premimum = 9.8 % - 4.85 %

Average nominal risk premimum = 4.95 %

Nominal Average return = Sum of returns / Number of year Year Retun 1 3% 2 -10% 3 26% 4 13% 5 17% Sum of returns 49% Number of years 5 Nominal average return 9.8% Average real return = [( 1 + nominal return) / ( 1 - inflation rate ) ] - 1 Nominal average return 9.80% Inflation rate = 3.40% Average real return = ( 1 + 9.8%)/(1+3.4%) - 1 6.19%

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