Question

Large company stocks 12%

Small company stocks 16.6%

Long term corporate bonds 6.3%

Long term government bonds 6.0%

US treasury bills 3.4%

Inflation 3.0%

a.	What was the average annual return on large-company stock from 1926 through 2016 in nominal terms? (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 annual return on large-company stock from 1926 through 2016 in real terms? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

     

a.	Government bonds		%
b.	Corporate bonds		%

   

Answer 1

This question requires application of Fischer relation, according to which

(1 + Nominal rate) = (1 + Real Rate) * (1 + Inflation)

a) For Government Bonds,

(1 + 6%) = (1 + Real rate) * (1 + 3%)

(1 + Real rate) = 1.06/1.03 = 1.0291

Real rate = 2.91%

b) For large company stocks,

(1 + 12 %) = (1 + Real rate) * (1 + 3%)

(1 + Real Rate) = 1.0874

Real rate = 8.74%

(Since, the question was not clear about what exactly is needed)

For corporate bonds,

(1 + 6.3%) = (1 + Real rate) * (1 + 3%)

(1 + Real Rate) = 1.063/1.03 = 1.0320

Real rate = 3.20%