Solutions 10-8-18

CHAPTER 10
RISK AND RETURN: LESSONS FROM MARKET HISTORY
8. We will calculate the sum of the returns for each asset and the observed risk premium first. Doing so, we get:

Year Large co. stock return T-bill return Risk premium 1973 –14.69% 7.29% (21.98% 1974 –26.47 7.99 –34.46 1975 37.23 5.87 31.36 1976 23.93 5.07 18.86 1977 –7.16 5.45 –12.61 1978 6.57 7.64 –1.07 19.41% 39.31% –19.90%

a. The average return for large company stocks over this period was:

Large company stock average return = 19.41% /6 Large company stock average return = 3.24%

And the average return for T-bills over this period was:

T. T-bills average return = 39.31% / 6 U. T-bills average return = 6.55% V. b. Using the equation for variance, we find the variance for large company stocks over this period was:

Variance = 1/5[(–.1469 – .0324)2 + (–.2647 – .0324)2 + (.3723 – .0324)2 + (.2393 – .0324)2 + (–.0716 – .0324)2 + (.0657 – .0324)2] Variance = 0.058136

And the standard deviation for large company stocks over this period was:

Standard deviation = (0.058136)1/2 Standard deviation = 0.2411 or 24.11%

Using the equation for variance, we find the variance for T-bills over this period was:

Variance = 1/5[(.0729 – .0655)2 + (.0799 – .0655)2 + (.0587 – .0655)2 + (.0507 – .0655)2 + (.0545 – .0655)2 + (.0764 – .0655)2] Variance = 0.000153

And the standard deviation for T-bills over this period was:

Standard deviation = (0.000153)1/2 Standard deviation = 0.0124 or 1.24%

c. The average observed risk premium over this period was:

Average observed risk premium = –19.90% / 6 Average observed risk premium = –3.32%

The variance of the observed risk premium was:

Variance = 1/5[(–.2198 –