Suppose a particular investment earns an arithmetic return of 10% in year 1, 20% in year 2, and 30% in year 3.The geometric average return for the period will be
A)greater than the arithmetic average return.
B)equal to the arithmetic average return.
C)less than the arithmetic average return.
D)equal to the market return.

Question

Quizplus · Accepted Answer

To calculate the geometric average return, we use the formula: [(1 + r1) x (1 + r2) x (1 + r3)]^(1/3) - 1.
Plugging in the values, we get [(1 + 0.1) x (1 + 0.2) x (1 + 0.3)]^(1/3) - 1 = 0.211 or 21.1%.
The arithmetic average return is (0.1 + 0.2 + 0.3) / 3 = 0.2 or 20%.
Since the geometric average return is greater than the arithmetic average return, the best choice is C.

Suppose a Particular Investment Earns an Arithmetic Return of 10