CMA Intermediate · Financial Management and Business Data Analytics · Risk and Return
Under CAPM, which type of risk is rewarded with a risk premium, and which measure captures it?
Systematic risk, measured by beta, is rewarded. Market-wide risk cannot be diversified away, so investors demand a premium for it, whereas company-specific risk can be eliminated by holding a diversified portfolio and earns no extra return under CAPM.
- AUnsystematic risk, measured by standard deviation
- BSystematic risk, measured by betaCorrect
- CTotal risk, measured by variance
- DUnsystematic risk, measured by beta
Explanation
Unsystematic risk can be removed by diversification, so the market does not pay for it. Only non-diversifiable (systematic) risk is priced, and beta measures it relative to the market. Standard deviation and variance measure total risk, which includes the diversifiable part.
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