The geometric return on a stock over the past 15 years has been 9.3%. The arithmetic return over the same period was 11.1%. What is the best estimate of the return on this stock over the next 10 years?
A) 11.04%
B) 10.20%
C) 9.94%
D) 10.61%
E) 11.87%

Question

Quizplus · Accepted Answer

The geometric return is a better measure of long-term performance because it accounts for the compounding effect. Therefore, we can assume that the future return on this stock will continue to follow the same trend and use the geometric mean to estimate it.

If we assume a 9.3% geometric return over the past 15 years, the total return over that time period would be (1 + 0.093)^15 - 1 = 375.5%. Using this total return, we can solve for the future expected return as follows:

(1 + x)^10 = 1 + 3.755
1 + x = (1 + 3.755)^(1/10)
1 + x = 1.0994
x = 0.0994 or 9.94%

Therefore, the best estimate for the return on this stock over the next 10 years is 9.94%, which is choice C.

The Geometric Return on a Stock Over the Past 15