Over the past five years, Teen Clothing stock produced returns of 18.7, 5.8, 7.9, 10.8, and 11.6 percent, respectively. For the same five years, the risk-free rate was 5.2, 3.4, 2.8, 3.4, and 3.9 percent, respectively. What is the arithmetic average risk premium on Teen Clothing stock for this time period?

Question

Quizplus · Accepted Answer

The arithmetic average risk premium on Teen Clothing stock can be found by subtracting the risk-free rate from the stock's return for each year, finding the average of those differences, and then taking the average over the five years.

Year 1: 18.7% - 5.2% = 13.5%
Year 2: 5.8% - 3.4% = 2.4%
Year 3: 7.9% - 2.8% = 5.1%
Year 4: 10.8% - 3.4% = 7.4%
Year 5: 11.6% - 3.9% = 7.7%

Average difference: (13.5% + 2.4% + 5.1% + 7.4% + 7.7%) / 5 = 7.22%

Therefore, the arithmetic average risk premium on Teen Clothing stock for this time period is 7.22%. The closest answer choice is (C) 7.22%, and thus it is the correct answer.

Over the Past Five Years, Teen Clothing Stock Produced Returns