Question

You’ve observed the following returns on Barnett Corporation’s
stock over the past five years: –28.5 percent, 16 percent, 35
percent, 3.5 percent, and 22.5 percent. The average inflation rate
over this period was 3.35 percent and the average T-bill rate over
the period was 4.3 percent.

What was the average real risk-free rate over this time period?
**(Do not round intermediate calculations and 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 and enter your answer as a percent
rounded to 2 decimal places, e.g., 32.16.)**

Average real risk premium
%

Answer #1

a) Average Real risk free rate = [ (1 + average nominal T - bill rate) / (1 + average inflation) ] - 1

or, Average real risk free rate = [ (1 + 0.043) / (1 + 0.0335) ]
- 1 = 0.009192 or **0.92%**

b) First compute the average nominal return and then use the real rate of return formula to compute the real return.

Average Nominal return = (-28.5% + 16% + 35% + 3.5% + 22.5%) / 5 = 9.7%

Average real return on stock = [ (1 + average nominal return on stock) / (1 + inflation) ] - 1

or, Average real return on stock = [ (1 + 0.097) / (1 + 0.0335) ] - 1 = 0.06144 or 6.14%

Average real risk premium = Average real return on stock -
Average real risk free rate = 6.14% - 0.92% = **5.22% [ or
5.23%]**

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