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 "nominal" returns on Crash-n-Burn Computer's stock over the past five years 2 percent, -11 percent, 30 percent, 14 percent, and 14 percent. The average inflation rate over this period was 3.8 percent and the average T-bill rate was 4.6 percent Requirement 1: What was the average "real" return on Crash-n-Burn's stock? Note: Use the Fisher Effect Formula from the Bond chapter to convert nominal to real rates of return. (Do not round intermediate calculations.) (Click to select) 7 Requirement 2: What was the average nominal risk premium on Crash-n-Burn's stock? (Do not round intermediate calculations.) (Click to select)

Explanation / Answer

1. Average Real Return Using Fisher Effect Formula

Average Real Return = (1 + Nominal Rate) / ( 1 + Inflation Rate) - 1

Average Real Return = (1 + 0.046) / ( 1 + 0.038) - 1 = 1.007707 - 1 = 0.7707% or 0.007707

2. Average Nominal Risk Premium

Average Nominal Return = (2+30+14+14-11)/5 = 9.80%

Average Nominal Risk Premium = 9.80% - 4.60% = 5.20%

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