Chapter 7, Problem 7-1, a, b, c. Page 231.

Expected Returns

(a)

Suppose that over the long run, the risk premium on stocks relative to Treasury bills has been 7.6%. Suppose also that the current Treasury bill yield is 1.5%, but the historical average return on treasury bills is 4.1%. Estimate the expected return on stocks and explain how and why you arrived at your answer.

Question:

Estimate the expected return on stocks and explain how and why you arrived at this answer.

Formula:

Solution:

Answer:

(b)

Historic risk premium on stocks relative to Treasury Bills has been 6.5%

Current T-bills yield is 4.5%

Historical avg return on T-bills is 5.2%

Question:

Estimate the expected return on stocks and explain how and why you arrived at this answer.

(c)

Compare your answers above and explain any differences.