NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Introduction to Modern Portfolio Theory
In the Capital Asset Pricing Model, the risk that is rewarded with a risk premium for a well-diversified investor is measured by which of the following?
Beta is the measure rewarded under CAPM. It captures systematic risk, which cannot be removed by diversification. Unsystematic risk can be diversified away, so the market does not pay a premium for it, and total standard deviation includes that unrewarded component.
- ATotal standard deviation of the security
- BBeta of the securityCorrect
- CUnsystematic risk of the security
- DVariance of the security's own returns
Explanation
CAPM states that only systematic (market) risk is compensated because unsystematic risk can be diversified away. Beta measures a security's sensitivity to market movements. Standard deviation and variance include diversifiable risk, so they are not priced.
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