The following table shows the nominal returns in Country A and Country B\'s stoc

Question

The following table shows the nominal returns in Country A and Country B's stock markets, and the rate of inflation in the past three years: Calculate r_ (deflating): r_ = (1 + r_n)/1 + pi -1 for each return. a) The average nominal market return over the years 2000 to 2002 for: Country A __ Country B ___ b) The standard deviation of nominal returns for: Country A ____ Country B ___ c) The average real market return over the years 2000 to 2002 for: Country A ___ Country B __ d) The standard deviation of real returns for: Country A ___ Country B ___ e) Assume you base your expectations of future returns on historical returns. If you are a risk averse investor, and minimizing risk is your priority, which country, A or B, will you invest in?

Explanation / Answer

a) Average nominal market return for Country A over 2000 to 2002=(15+12-5)/3=7.33% [using formula for average, xbar=sigma x/n, where, x corresponds to nominal market return for years over 2000 to 2002, and n is number of years]

Average nominal market return for Country B over 2000 to 2002=(5+8+7)/3=6.67%

b) Standard deviation for nominal return for country A is: sA=1/3-1 {(15-7.33)^2+(12-7.33)^2+(-5-7.33)^2}]=10.79 [Using formula s=sqrt[1/n-1 sigma (x-xbar)^2]

Similarly, sB=sqrt[1/3-1 {(5-6.67)^2+(8-6.67)^2+(7-6.67)^2}]=1.53

c) Substitute given values in the formula given and obtain the real return. The real return for country A for year 2000, 2001 and 2002 are 2.86% [{(1+15)/(1+3.142)}-1], 2.14% and -1.97% respectively.

Average real return return for Country A over 2000 to 2002=(2.86+2.14-1.97)/3=1.01%

The real return for country B are 0.45% [{1+5)/(1+3.142)}-1], 1.17%, 0.93%

Average real return return for Country B over 2000 to 2002=(0.45+1.17+0.93)/3=0.85%

d) The standard deviation for real return for country A is, sA: sqrt[1/3-1 {(2.86-1.01)^2+(2.14-1.01)^2+(-1.97-1.01)^2}]=2.61%

Similarly, the standard deviation for real return for country B is, sB=0.37%

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