Question

You’ve observed the following returns on SkyNet Data Corporation’s stock over the past five years: 11 percent, –10 percent, 19 percent, 18 percent, and 10 percent. Suppose the average inflation rate over this period was 2.7 percent and the average T-bill rate over the period was 4.8 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.)

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.)

Answer 1

1) (1 + Nominal rate of return) = (1 + Real rate of return)(1 + Inflation rate)

(1 + 0.048) = (1 + Real rate of return)(1 + 0.027)

Real rate of return = [(1 + 0.048) / (1 + 0.027)] - 1

Real rate of return = 0.0204 or 2.04%

2) Average return = Sum all the returns / Number of returns

Average return = (0.11 - 0.10 + 0.19 + 0.18 + 0.10) / 5

Average return = 0.096 or 9.6%

(1 + Nominal rate of return) = (1 + Real rate of return)(1 + Inflation rate)

(1 + 0.096) = (1 + Real rate of return)(1 + 0.027)

Real rate of return = [(1 + 0.096) / (1 + 0.027)] - 1

Real rate of return = 0.0672 or 6.72%

Average real risk premium = Real return - risk free rate

Average real risk premium = 6.72% - 2.04%

Average real risk premium = 4.68%