Here are Costaguanan inflation rates and stock market and Treasury bit! returns between 1929 and...

Question:

Here are Costaguanan inflation rates and stock market and Treasury bit! returns between 1929 and 1933

Year Inflation Stock market return T-bill return
1929 -0.1 -11.8 6.1
1930 -3.7 -30.6 3.8
1931 -8.5 -40.6 1.3
1932 -10.4 -9.3 1.0
1933 0.5 57.20 0.6

What was the real return on the stock market m each year1? (Negative values should be indicated by a minus sign. Do not round intermediate calculations Round your answers to 1 decimal place.)

Wh8t was the average real return-? (Negative value should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

What was the risk premium in each year? (Negative values should be indicated by a minus sign Round your answers to 1 decimal place.)

What was the average risk premium ? (Negative values should be indicated by a minus sign Round your answers to 1 decimal place.)

Risk Premium:

Risky assets, such as stocks, on average earn a higher return than risk-free assets, such as treasury bonds. The difference between the returns is called the risk premium. Specifically, the difference between stock return and risk-free rate is called the equity premium.

Answer and Explanation:

Real stock market return is calculated as follows:

  • real stock market return = nominal stock market return - rate of inflation

The risk premium is calculated as follows:

  • risk premium = nominal stock market return - nominal T-bill return

Applying these two formulas, the annual real stock market return and the annual risk premium are given in the table below:

Year Inflation Stock market return T-bill return Real Return Risk Premium
1929 -0.1 -11.8 6.1 -11.7 -17.9
1930 -3.7 -30.6 3.8 -26.9 -34.4
1931 -8.5 -40.6 1.3 -32.1 -41.9
1932 -10.4 -9.3 1 1.1 -10.3
1933 0.5 57.2 0.6 56.7 56.6

The average real stock market return = (-11.7% - 26.9% - 32.1% + 1.1% + 56.7%) / 5 = -2.58%.

The average risk premium = (-17.9% - 34.4% - 41.9% - 10.3% + 56.6%) / 5 = -9.58%.


Learn more about this topic:

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How to Calculate Risk Premium: Definition & Formula

from Financial Accounting: Help and Review

Chapter 5 / Lesson 26
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