An analyst observes the following historic geometric returns:
Corporate Bonds 6.5%
Treasury Bills 2.5%
The risk premium for equities is closest to:
Why is the answer is A? Surely we need to obtain the real rate of return for equities which is 5.8% (1.08/1.021) and then divide this by the treasury bill (risk-free) rate of 1.025. Yet the book uses the nominal return in the top half of the fraction (1.08/1.025)?
In the book it says that the REAL RATE of interest is equal to (1+Rf)x(1+Rp) NOT the nominal rate of interest so I’m confused as to why they’ve used the nominal rate to compute the risk premium. Any ideas?