Consider the following information on different asset classes from 1926 through

Question

Consider the following information on different asset classes from 1926 through 2011.

Series                                           Arithmetic Mean

Large-Company Stocks                         11.8%

Small-Company Stockst                         16.5

Long-term corporate bonds                     6.4

Long-term government bonds                 6.1

Intermediate-term government bonds     5.5

U.S. Treasury bills                                   3.6

Inflation                                                    3.1

Requirement 1: What is the real return on long-term government bonds? ______% (two decimal places)

Requirement 2: What is the real return on long-term corporate bonds? ______% (two decimal places)

I was given the wrong answer (and missing information) on this the first time...

Explanation / Answer

1.

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

(1.061) = (1+real rate)*(1.031)

(1+real rate) = 1.061/1.031

real rate = (1.061/1.031) -1

= 2.91% or 2.9098% ( real return on long-term government bonds)

2.

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

(1.064) = (1+real rate)*(1.031)

(1+real rate) = 1.061/1.031

real rate = (1.064/1.031) -1

= 3.20% or 3.2008%(the real return on long-term corporate bonds)

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