You've observed the following returns on a particular company's stock over the past five years: 3%, -10%, 24%, 22%, and 12%. Suppose the average inflation rate over this time period was 3.6% and the average U.S. Treasury bill rate was 4.8%. Using an arithmetic average, what was the average nominal risk premium based on this information?
Equity Risk Premium:
Equity risk premium is the difference between average return on equity, i.e., stocks, and the average return on risk-free assets. Treasury bond yields are often used as a benchmark for risk-free returns.
Answer and Explanation:
The answer is B.
The arithmetic average stock return is:
- average stock return = (3% - 10% + 24% + 22% + 12%) / 5
- average stock return = 10.2%
Average nominal risk premium = average stock return - average T-bill return = 10.2% - 4.8% = 5.4%
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from Financial Accounting: Help and ReviewChapter 5 / Lesson 26