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, –10 percent, 17 percent, 22 percent, and 10 percent. Suppose the average inflation rate over this period was 1.5 percent and the average T-bill rate over the period was 3 percent.

a. 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.) Average real return %

b. 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.) Average nominal risk premium %

Explanation / Answer

1)

Each year real return = Nominal return - Inflation

Rreal return each year are (10-1.5), (-10-1.5), (17-1.5), (22-1.5), (10-1.5)

Real return are -8.5%, -11.5%, 15.5%, 20.5% and 8.5%.

Aaverage real return = (-8.5-11.5+15.5+20.5+8.5)/5

= 24.5/5 = 4.9%

2)

Aaverage nominal return = (10% - 10% + 17% + 22% + 10%)/5 = 9.8%

Average nominal risk premium = Aaverage nominal return - T-bill rate

   = 9.8% - 3% = 6.8%

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