Question

You’ve observed the following returns on Crash-n-Burn Computer’s stock over the past five years: 16 percent, –5 percent, 19 percent, 13 percent, and 10 percent. Suppose the average inflation rate over this period was 2.2 percent and the average T-bill rate over the period was 5.3 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 %

Answer 1

Answer:

(A) 8.22%

(B) 7.5%

Explanation:

The first step is to calculate the average nominal return

Average nominal return= R1 + R2 + R3 + R4 + R5/5

= 16 +(-5) + 19 + 13 + 10/5

= 16-5+19+13+10/5

= 53/5

= 10.6%

(A) The average real return can be calculated as follows

= (1 + average nominal return)/(1+ inflation) -1

= (1+ 10.6/100)/(1+2.2/100) -1

= (1+0.106)/(1+0.022)-1

= 1.106/1.022-1

= 1.08219-1

= 0.08219 × 100

= 8.22%

(B) The average nominal risk premium can be calculated as follows

Average risk free rate= Nominal average t-Bill rate-inflation

= 5.3% - 2.2%

= 3.10%

Average nominal risk premium= average nominal return -average risk free rate

= 10.6% - 3.10%

= 7.5%