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You've observed the following returns on a particular company's stock over the past five years:...

Question:

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?

A.5.15%

B.5.40%

C. 6.01%

D. 6.37%

E.6.60%

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%


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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