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: 10 percent, –11 percent, 18 percent, 19 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 4.7 percent.

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.)

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.)

You’ve observed the following returns on Crash-n-Burn Computer’s stock over the past five years: 10 percent, –11 percent, 18 percent, 19 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 4.7 percent.

Explanation / Answer

a)

Average return = (10+18+19+10) -11 / 5 = 46/5 = 9.2

(1+nominal)=(1+real)*(1+inflation)

Therefore Average real return = 1.0920 / 1.022 = 1.068

Average real return = 1.068 -1 = 0.068 or 6.8%

b)

The nominal risk premium is the difference between the average return and the risk free return

So Average nominal risk premium = 11.40 - 4.7 = 6.70%

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