# You ve observed the following returns on Barnett Corporation s stock over the past 5 years:...

## Question:

You ve observed the following returns on Barnett Corporation s stock over the past 5 years: 26.1%, 14.4%, 31.8%, 2.7%, and 21.7%. The average inflation rate over this period was 3.27% and the average T-bill rate over the period was 4.3%.

a. 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.

Average real risk-free rate _____%

b. What was the average real risk premium? Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places.

Average real risk premium _____%

## Risk Premium:

The risk premium of an asset is the expected return on the asset, net of the risk-free rate. The risk-free rate is often approximated by the return on U.S. Treasury notes.

## Answer and Explanation:

**a. Average real risk-free rate**

The average real risk-free rate is the average nominal risk-free rate net of the average inflation rate. The nominal risk-free rate is the average T-bill rate, which is 4.3%. The average inflation is 3.27%, thus the average real risk-free rate is:

- average real risk free rate = 4.3% - 3.27% = 1.03%

*Average real risk-free rate is 1.03%.*

**b. Average real risk premium**

The average real risk premium is the average real return on Barnett Corporation stock minus the real risk-free rate. The average real return on Barnett Corporation stock is the average nominal return on Barnett Corporation stock minus the average rate of inflation, i.e.,

- (26.1% + 14.4% + 31.8% + 2.7% + 21.7%) / 5 - 3.27% = 16.07%

The average real risk premium = 16.07% - 1.03% = 15.04%.

*Average real risk premium is 15.04%.*

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from Financial Accounting: Help and Review

Chapter 5 / Lesson 26