Question

# Problem 10-8 Risk Premiums [LO 2] Consider the following table for a period of six years:...

Problem 10-8 Risk Premiums [LO 2]

Consider the following table for a period of six years:

 Returns Year Large-Company Stocks U.S. Treasury Bills 1 –15.99 % 7.55 % 2 –26.86 8.12 3 37.49 6.13 4 24.19 6.37 5 –7.68 5.58 6 6.83 8.03

Calculate the arithmetic average returns for large-company stocks and T-bills over this time period. (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

 Arithmetic average returns Large-company stock % T-bills %

Calculate the standard deviation of the returns for large-company stocks and T-bills over this time period. (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

 Standard deviation Large-company stock % T-bills %

Calculate the observed risk premium in each year for the large-company stocks versus the T-bills.

a. What was the arithmetic average risk premium over this period? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Average risk premium             %

b. What was the standard deviation of the risk premium over this period? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Risk premium standard deviation             %

Arithmetic average returns:

Large stock = (-15.99-26.86+37.49+24.19+6.83-7.68)/6 = 2.99%

Treasury = (7.55+8.12+6.13+6.37+5.58+8.03)/6 = 6.96%

Standard deviation of returns:

Large stock = 54.95%

Treasury = 2.4%

a) Average risk premium = 2.99-6.96 = -3.97%

b) Risk premium std deviation = 54.95-2.4 = 52.55%