P12-10 Calculating Real Returns and Risk Premiums [LO1] You\'ve observed the fol

Question

P12-10 Calculating Real Returns and Risk Premiums [LO1]

You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 7 percent, -12 percent, 11 percent, 38 percent, and 14 percent.

The arithmetic average return on Crash-n-Burn's stock over this five year period was percent. (Do not include the percent sign (%). Round your answer to 2 decimal places. (e.g., 32.16))

Suppose the average inflation rate over this time period was 3.5 percent and the average T-bill rate over the period was 4.2 percent. The average real return on Crash-n-Burn's stock was percent and the average nominal risk premium on Crash-n-Burn's stock was percent. Use the Fisher Effect formula to convert nominal rates to real rates and vice versa. (Do not include the percent signs (%). Round your answers to 2 decimal places. (e.g., 32.16))

You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 7 percent, -12 percent, 11 percent, 38 percent, and 14 percent.

Explanation / Answer

a. arithmetic average return = (7%-12%+11%+38%+14%)/5 =11.60%

b. real interest rate = nominal interest rate - the expected inflation rate

average real return on Crash-n-Burn's stock = 11.6% -3.5% = 8.10%

average nominal risk premium on Crash-n-Burn's stock = 11.6%-4.2%= 7.40%

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