Question

Within the capital asset pricing model, what does the term 'beta' represent?

1) The expected return on a security
2) The risk-free rate of return
3) The measure of systematic risk
4) The measure of unsystematic risk

Answer 1

In the capital asset pricing model, 'beta' represents the measure of systematic risk. (Option 3)

Step-by-step explanation:

Beta is a measure of the systematic risk, often referred to as market risk, associated with an individual security or investment portfolio. It quantifies how sensitive the returns of that security or portfolio are to changes in the overall market or a relevant market index. Specifically, beta compares the asset's historical price movements to the overall market's price movements.

A beta of 1 indicates that the asset's returns move in line with the market. A beta greater than 1 implies that the asset is more volatile (risky) than the market, while a beta less than 1 suggests it is less volatile.

Beta is crucial in the CAPM formula, which helps investors estimate the expected return on an asset by factoring in its beta, the risk-free rate of return, and the market risk premium. It enables investors to assess the asset's risk and potential return in relation to the broader market, aiding in investment decision-making.

Therefore, the correct answer is: 3) The measure of systematic risk.