The Average Annual Return on the S&P 500

Question One 

The average annual return on the S&P 500 Index from 1986 to 1995 was 15.8 percent. The average annual T-bill yield during the same period was 5.6 percent. What was the market risk premium during these ten years? 

Market Risk Premium = S&P 500 rate – T. Bill Rate

Therefore, Market Risk Premium for ten years will be: 15.8-10.2 = 10.2

The market risk premium is the market's risk of return over the risk-free rate of return which is the T-bill rate. Investors understand this as the reward of taking a risk by investing in the stock market. (Ref Worksheet Difficult: 1 Basic).

Question Two 

Paccar’s current stock price is $48.20 and it is likely to pay a $0.80 dividend next year. Since analysts estimate Paccar will have an 8.8 percent growth rate, what is its required return? 

Required Return 

I = (D1/P0) + g = ($0.80/$48.2) + 0.088 = 0.1046 = 10.46%

Question Three 

If the risk-free rate is 3 percent and the risk premium is 5 percent, what is the required return? 

Required Return = Risk Premium + Risk-free rate

= 5% + 3% = 8%

Risk free rate is more often connected to U.S. government bonds.

Question Four 

Netflix, Inc. has a beta of 3.61. If the market return is expected to be 13 percent and the risk-free rate 

is 3 percent, what is Netflix’s risk premium? 

Netflix Company Risk Premium = 3.61 x (13% - 3%) = 36.1%

Question Five 

The NASDAQ stock market bubble peaked at 4,816 in 2000. Two and a half years later it had fallen to 1,000. What was the percentage decline? 

% Change = 1000/4816 = 0.2076

= (0.2076 (1/2.5) – 1) x 100 = -46.99%

Question Six 

Compute the expected return given these three economic states, their likelihoods, and the potential returns: 

Expected Return = 12% + 4%+ -7.5% = 8.5%