You?ve observed the following returns on Doyscher Corporation?s stock over the past five years: 28.5 percent, 16.0 percent, 35.0 percent, 3.5 percent, and 22.5 percent. The average inflation rate over this period was 3.35 percent and the average T-bill rate over the period was 4.3 percent.
(a) What was the average real return on the stock? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) Average real return %
(b) What was the average nominal risk premium on the stock? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) Average nominal risk premium%
Equity Risk Premium:
Equity investment on average provides a higher return than treasury bonds, because equity investment is considered riskier. According to the modern portfolio theory, there is a trade-off between risk and return. This difference in return is known as the equity risk premium.
Answer and Explanation:
a) The average real return on the stock is 17.75%.
The average real return on the stock is the average nominal return net of the average inflation rate. We first compute the average nominal return, which is:
- average nominal return = (28.5% + 16% + 35% + 3.5% + 22.5%) / 5 = 21.1%
The average rate of inflation is 3.35%, thus the average real rate of return = 21.1% - 3.35% = 17.75%.
b) The average nominal risk premium is 16.8%.
The average nominal risk premium is the average nominal return net of the average return on treasury bills, i.e.,
- average nominal risk premium = 21.1% - 4.3% = 16.8%
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from Financial Accounting: Help and ReviewChapter 5 / Lesson 26