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: 16 percent, –16 percent, 18 percent, 28 percent, and 10 percent. Suppose the average inflation rate over this period was 2.1 percent and the average T-bill rate over the period was 4.2 percent.

What was the average real risk-free rate over this time period?

(Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Average real risk-free rate ....... %

What was the average real risk premium?

(Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Average real risk premium ...... %

Explanation / Answer

Answer)

First we calculate the average return for crash-n-burn computer over 5 year period i.e

(16%+(-16%) + 18% + 28% + 10% ) / 5

= 11.20%

Average inflation = 2.1%

Average T-bill rate = 4.2%

Average real rate for crash n burn computers= [(1+ return)/(1+ inflation)] - 1

=[ (1+0.1102) / (1+0.021) ] -1 = 0.08913 or 8.913%

Average real risk free rate (T-bills) =[ (1+0.0421) / (1+0.021) ] -1 = 2.057%

Average real risk premium = 8.913% - 2.057% = 6.8561%

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