Question

You’ve observed the following returns on Crash-n-Burn Computer’s stock over the past five years: 13 percent, –8 percent, 16 percent, 16 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 5 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 %

Answer 1

Answer:

Average real risk free rate = (1 + Nominal risk free rate / 1 + Inflation rate ) - 1

= (1 + 5% / 1 + 1.5%) - 1

= 1.0345 - 1

= 0.0345

= 3.45%

Average return on stock = Sum of annual returns / Number of years

= 13% + (-8%) + 16% + 16% + 10% / 5

= 0.47 / 5

= 0.094

= 9.40%

Average real returns = (1 + Average return on stock / 1 + Inflation rate) - 1

= (1 + 9.40% / 1 + 1.5%) - 1

= 1 + 0.0940 / 1 + 0.015) - 1

= 1.077832512 - 1

= 0.077832512

=  7.78%

Average real risk premium = Average real return - Average real risk free rate

Average real risk premium = 7.78% - 3.45%

Average real risk premium =4.33%