This doesn’t make much sense to me. According to the a previous problem, r is indeed the nominal return (i.e. 8%) and PP = 2.1%. I’m not sure why the answer is the way it is. Any help would be much appreciated!

Can you actually give the answer in a number? you formular is division but your example is with multiplicaiton.

However if the answer is 5.4% then I think it is correct, since the equity risk premium is the premium for investing in equity over holding risk free asset, which is T-bill.

(Sort of) understood. I can rewrite an equation to get (1+rr) / (1+RF) = 1+RP and everything makes sense save for the real rate of return = 8%, the nominal rate as stated in the book.

You rewrote it correctly. The exact equation depends on what the question is asking you for. They ask you for equity risk premium, and it is assumed to be in nominal term (unless stated otherwise). Therefore, use T-bill (nominal term) and equity return (nominal term) then no need for inflation.

If they give you: real risk free rate (let say the same 2.5%), then you do (1+r) = (1 + 0.08) / [(1 + 0.025) x (1+ 0.021)]

Corporate bond is not relevant in calculating equity risk premium (well not until Level 2, when they teach about bond yield plus risk premium approach)

I know that it is a bit confusing at first, but if you get a understanding of what each rate means and WHY they want to calcualate in for the real life application, the remembering will come much easier.