1. Real versus nominal returns

1. Real versus nominal returns The Costaguana stock market provided a rate of return of 95%. The inflation rate in Costaguana during the year was 80%. In Ruritania the stock market return was 12%, but the inflation rate was only 2%. Which country’s stock market provided the higher real rate of return?

2. Arithmetic average and compound returns* Integrated Potato Chips (IPC) does not pay a dividend. Its current stock price is $150 and there is an equal probability that the return over the coming year will be –10%, +20%, or +50%.

a. What is the expected price at year-end?

b. If the probabilities of future returns remain unchanged and you could observe the returns of IPC over a large number of years, what would be the (arithmetic) average return?

c. If you were to discount IPC’s expected price at year-end from part (a) by this number, would you underestimate, overestimate, or correctly estimate the stock’s present value?

d. If you could observe the returns of IPC over a large number of years, what would be the compound (geometric average) rate of return?

e. If you were to discount IPC’s expected price at year-end from part (a) by this number, would you underestimate, overestimate, or correctly estimate the stock’s present value?

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