You’ve observed the following returns on Crash-n-Burn Computer’s stock over the past five years: 14 percent, –14 percent, 16 percent, 26 percent, and 10 percent. Suppose the average inflation rate over this period was 3.5 percent and the average T-bill rate over the period was 4 percent.

You’ve observed the following returns on Crash-n-Burn Computer’s stock over the past five years: 14 percent, –14 percent, 16 percent, 26 percent, and 10 percent. Suppose the average inflation rate over this period was 3.5 percent and the average T-bill rate over the period was 4 percent.



a.
What was the average real return on the company’s stock? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

b. What was the average nominal risk premium on the company’s stock? (Do not round intermediate calculations and enter your answer as a percent rounded to 1 decimal place, e.g., 32.1.)

Explanation

a.

To find the average return, we sum all the returns and divide by the number of returns, so:

Average return = (.14 – .14 + .16 + .26 + .10)/5

Average return = .104, or 10.4%

To calculate the average real return, we can use the average return of the asset, and the average inflation rate in the Fisher equation. Doing so, we find:

(1 + R) = (1 + r)(1 + h)

= (1.104/1.035) – 1

= .0667, or 6.67%

b.

The average risk premium is the average return of the asset, minus the average risk-free rate, so, the average risk premium for this asset would be:

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

Average risk premium = .104 − .040

Average risk premium = .064, or 6.4%

Thanks