CHAPTER ONE 
                           Introduction to Investing and Valuation 
Concept Questions 
C1.1.    Yes. Stocks would be efficiently priced at the agreed fundamental value and the market 
price would impound all the information that investors are using. Stock prices would change as 
new information arrived that revised the fundamental value.  But that new information would be 
unpredictable beforehand.      So changes in prices would also be unpredictable: stock prices would 
follow a “random walk.” 
C1.2.    Index investors buy a market index--the S&P 500, say--at its current price.            With no one 
doing fundamental analysis, no one would have any idea of the real worth of stocks.  Prices 
would wander aimlessly, like a “random walk.” A lone fundamental investor might have 
difficulty making money.  He might discover that stocks are mispriced, but could not be sure that 
the price will ultimately return to “fundamental value.” 
C1.3.     Fundamental risk arises from the inherent risk in the business – from sales revenue falling 
or expenses rising unexpectedly, for example. Price risk is the risk of prices deviating from 
fundamental value.      Prices are subject to fundamental risk, but can move away from fundamental 
value, irrespective of outcomes in the fundamentals. When an investor buys a stock, he takes on 
fundamental risk – the stock price could drop because the firm’s operations don’t meet 
expectations – but he also runs the (price) risk of buying a stock that is overpriced or selling a 
stock that is underpriced. See Box 1.1. Chapter 18 elaborates. 
                                                          Introduction to Investing and Valuation – Chapter 1 p.  1 
C1.4.    A beta technology measures the risk of an investment and the required return that the risk 
requires. The capital asset pricing model (CAPM) is a beta technology; is measures risk (beta) 
and the required return for the beta. An alpha technology involves techniques that identify 
mispriced stocks than can earn a return in excess of the required return (an alpha return). See 
Box 1.1. The appendix to Chapter 3 elaborates of beta technologies. 
C1.5.    This statement is based on a statistical average from the historical data: The return on 
stocks in the U.S. and many other countries during the twentieth century was higher than that for 
bonds, even though there were periods when bonds performed better than stocks. So, the 
argument goes, if one holds stocks long enough, one earns the higher return. However, it is 
dangerous making predictions from historical averages when risky investment is involved. Those 
averages from the past are not guaranteed in the future. Stocks are more risky than bonds – they 
can yield much lower returns than past averages. The investor who holds stocks (for retirement, 
for example) may well find that her stocks have fallen when she comes to liquidate them. 
Waiting for the “l

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