Question

Saved Assume that the historical return on large-company stocks is a predictor of the future returns. What return would you estimate for large-company stocks over the next year? The next 10 years? 20 years? 40 years? Refer to Table 12.4 (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) 1 year 10 years 20 years 40 years

Answer 1

Solution The formula that we will use to compute the returns is: R(T) = (T-1)/(N-1)*geometric average return + (N-T)/(N-1)*arithmetic average return

Here N = no. of years of historical data. From 1926 to 2016 the number of years (both years included) will be = 91 years.

(i) Forecast for the next year: Here T = 1 and so R(T) = (1-1)/(91-1)*10% + (91-1)/(91-1)*12%

= 12%

(ii) Next 5 years: Here T = 5 and so R(T) = (5-1)/(91-1)*10% + (91-5)/(91-1)*12%

= 0.444% + 11.467% = 11.91%

(iii) next 20 years: Here T = 20 and so R(T) = (20-1)/(91-1)*10% + (91-20)/*(91-1)*12%

= 2.11% + 9.466% = 11.58%

(iv) next 30 years: Here T = 30 and so R(T) = (30-1)/(91-1)*10% + (91-30)/(91-1)*12%

= 3.22% + 8.133% = 11.36%