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Concept Review Questions
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  1. Explain the difference between the arithmetic average and the compound annual return. Which one is higher? (page 175)


  2. If stock prices rise faster than dividends, one possible explanation is that the cost of capital has fallen. Explain why. Would an average of past returns over or under estimate the cost of capital? (page 179)


  3. What are the formulas for the variance and standard deviation of returns? (page 181)


  4. What are the two types of risk? Which one can be reduced by diversification? (page 188)


  5. What is the general formula for calculating the risk of a portfolio? (pages 191-192)


  6. What is beta and what is its average value? (page 193)


  7. Explain why diversification makes sense for an investor, but not generally for the firm itself. (pages 197-198)





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