Calculating the geometric and arithmetic average rate of return) The common stock of the Brangus Cattle...

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Calculating the geometric and arithmetic average rate of return) The common stock of the Brangus Cattle...

Calculating the geometric and arithmetic average rate of return) The common stock of the Brangus Cattle Company had the following end-of-year stock prices over the last five years and paid no cashdividends:

Time	Brangus cattle Comapny
1	$14
2	8
3	10
4	21
5	27

a. Calculate the annual rate of return for each year from the above information.

b. What is the arithmetic average rate of return earned by investing in Brangus Cattle Company's stock over this period?

c. What is the geometric average rate of return earned by investing in Brangus Cattle Company's stock over this period?

d. Which type of average rate of return best describes the average annual rate of return earned over the period (the arithmetic or geometric)? Why?

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Answer 1

Answer #1

Calculate the different types of returns as follows:

Reason:

Geometric average return best describes the average annual rate of return over a period because it takes compounding into account, so it answers the question concerning the expected rate of return over a multi-year period.

Geometric average considers compounding. Average return considers simple interest not compounding. So, geometric average is best.

Formulas:

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Answer 2

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