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?
b. What was the average nominal risk premium on Crash-n-Burn's stock?

Answer 1

Answer:

Crash-n-Burn Computers

a. The average real return on Crash-n-Burn's stock is:

= 8.3%

b. The average nominal risk premium on Crash-n-Burn's stock is:

= 6.8%

Explanation:

a) Data and Calculations:

Average inflation rate = 1.5%

Average T-bill rate = 3%

Returns on stock:

Year 1 = 10%

Year 2 = -10%

Year 3 = 17%

Year 4 = 22%

Year 5 = 10%

Total returns  = 49%

Average returns = Total returns/number of years

= 9.8% (49%/5)

Average real returns

= Average returns on the stock minus the inflation rate

= 8.3% (9.8% - 1.5%)

Average nominal risk premium = return on the stock minus the return on the T-bill

= 9.8% - 3%

= 6.8%