Problem 10-11 Calculating Real Rates [LO 1] You’ve observed the following return

Question

Problem 10-11 Calculating Real Rates [LO 1]

You’ve observed the following returns on Doyscher Corporation’s stock over the past five years: –24.9 percent, 13.6 percent, 30.2 percent, 2.3 percent, and 21.3 percent. The average inflation rate over this period was 3.23 percent and the average T-bill rate over the period was 4.3 percent.

What was the average real risk-free rate over this time period? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

What was the average real risk premium? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

You’ve observed the following returns on Doyscher Corporation’s stock over the past five years: –24.9 percent, 13.6 percent, 30.2 percent, 2.3 percent, and 21.3 percent. The average inflation rate over this period was 3.23 percent and the average T-bill rate over the period was 4.3 percent.

Explanation / Answer

Average nominal return = (-24.9+13.6+30.2+2.3+21.3)/5 = 8.5%

Average real risk free rate = ((1+nominal rate)/(1+inflation rate)-1)*100

=((1+0.043)/(1+0.0323)-1)*100 = 1.04%

Average real return = ((1+nominal rate)/(1+inflation rate)-1)*100

=((1+0.085)/(1+0.0323)-1)*100 = 5.11%

Real Risk premium = 5.11-1.04 = 4.07%

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