| 5.a. | ||||||||
| Stock T | Stock B | |||||||
| Year | Return | Return – AM | (Return – AM)^2 | Return | Return – AM | (Return – AM)^2 | ||
| 1 | 0.19 | 0.136 | 0.018496 | 0.08 | 0.136 | 0.136 | ||
| 2 | 0.08 | 0.026 | 0.05400000000000001 | 0.03 | 0.05400000000000001 | 0.05400000000000001 | ||
| 3 | -0.12 | -0.174 | 0.05400000000000001 | -0.09 | 0.05400000000000001 | 0.05400000000000001 | ||
| 4 | -0.03 | -0.08400000000000001 | 0.05400000000000001 | 0.02 | 0.05400000000000001 | 0.05400000000000001 | ||
| 5 | 0.15 | 0.09599999999999999 | 0.05400000000000001 | 0.04 | 0.05400000000000001 | 0.05400000000000001 | ||
| Sum | 0.27 | 0.018496 | 0.018496 | 0.018496 | ||||
| a. | AM | 0.05400000000000001 | 0.018496 | |||||
| b. | SD | 0.1282 | 0.0092 | |||||
| c. | CV | 2.37 | 0.05 | |||||
| d. | GM | 0.04757371465938132 | 0.018496 | |||||
| Stock T is desirable as per AM | ||||||||
| Stock B is preferable as per SD | ||||||||
| Stock T is desirable as per CV | ||||||||
| Stock T has more variability than Stock B. Greater the variability of returns, greater the difference in arithmetic an geometric mean | ||||||||
| 7 | Possible Rate of Return | Probability | ||||||
| -0.60 | 0.05 | |||||||
| -0.30 | 0.2 | |||||||
| -0.10 | 0.1 | |||||||
| 0.20 | 0.3 | |||||||
| 0.40 | 0.2 | |||||||
| 0.80 | 0.15 | |||||||
| Expected Return | 0.1600 | |||||||
| Expected return [E(Ri)] on Lauren Computer stock is 16% | ||||||||
| 9 | U.S. government T-bills | 5.50% | ||||||
| U.S. government long-term bonds | 7.50% | |||||||
| U.S. common stocks | 11.60% | |||||||
| Inflation rate = (172 – 160)/160 | ||||||||
| Inflation rate | 7.50% | |||||||
| Real U.S. T-Bill Rate | -1.86% | |||||||
| Real U.S. L.T. Bond Rate | 0.00% | |||||||
| Real U.S. Stock Return | 3.81% | |||||||
| 12 | Nominal Rate on T-bills = (1+0.03)*(1+0.05)-1 | |||||||
| 8.15% | ||||||||
| Risk premium = Stock Return – Nominal T-Bill Rate | ||||||||
| 5.85% | ||||||||
| Alternatively, the risk premium can also be calculated as: | ||||||||
| Formula: (1+Stock Return)/(q1+Nominal T-Bill Rate)-1 or (1.14)/(1.0815)-1 | ||||||||
| 5.41% | ||||||||
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