Question

You’ve observed the following returns on SkyNet Data Corporation’s stock over the past five years: 12 percent, –9 percent, 20 percent, 17 percent, and 10 percent. Suppose the average inflation rate over this period was 3.2 percent and the average T-bill rate over the period was 4.9 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.)

Average real risk-free rate ______% (1.65?)

Average real risk premium ______%

Answer #1

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

(1 + 0.049) = (1 + Real rate of return)(1 + 0.032)

Real rate of return = [(1 + 0.049) / (1 + 0.032)] - 1

Real rate of return = 0.0165 or **1.65%**

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

Average return = (0.12 - 0.09 + 0.20 + 0.17 + 0.10) / 5

Average return = 0.10 or 10%

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

(1 + 0.10) = (1 + Real rate of return)(1 + 0.032)

Real rate of return = [(1 + 0.10) / (1 + 0.032)] - 1

Real rate of return = 0.0659 or 6.59%

Average real risk premium = Real return - risk free rate

Average real risk premium = 6.59% - 1.65%

Average real risk premium = **4.94%**

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