Chapter 10:
Question 9: A) CAGR = [(1+R1)(1+R2)(1+R3)(1+R4)]1/T -1
= [(1 +0.1)(1 +0.2)(1-0.05)(1+0.15)]1/4 -1
= 0.095 9.5% B) Average Annual Return = 1/T(R1+R2+R3+R4)
= ¼(0.1+0.2-0.05+0.15)
= 0.10 10% C) Compound Annual Growth Rate is a better measure of investment’s past performance D) Average Annual Return is a better measure in this case

Question 14:
The relationship between average return and volatility of individual stocks displayed in figure 10.6 shows that the volatility of even the largest stock is typically higher than the volatility of the portfolio of large stocks. There is also no clear relationship between volatility and return. Many stocks have higher volatility and lower average return than the large portfolio.

Question 18:
Bank A faces less risk than Bank B because of diversification of risk within the 100 loans in case of Bank A
Question 20:
Will choose the second economy because the risk can be diversified
Question 21:
Type S and Type I Return = 0.6(0.15) + 0.4(-0.1) = 0.05 5%
SD(RS) = [0.6(0.15-0.05)2 + 0.4(-0.1-.05)]1/2 = .34%

SD(Average of Independent, identical risks) = SD(Individual Risk)/(Number of observations)1/2

a) Type S Firm Volatility remains constant

b) Type I Firm Volatility = .034/(20)1/2 = 0.076%

Question 23:
Risk premium of diversifiable risk is zero. This is due to the application of Law of one price. Stocks can be combined into large portfolio to minimize the risk and essentially earn the risk-free interest rate.
Question 35:
Market Risk Premium = 6.5
Risk Free Interest Rate = 5% β = 1.2
Cost of Capital = Risk Free Interest Rate + β ( Market Risk Premium) = 5% + 1.2(6.5%) = 12.8%