Beta as a Measure of Risk
Course: Investment Planning
Lesson 1: Key Principles of Investing
Student Question:
In the CFP Board question below I’m wondering why (1) is part of the correct answer. How is beta a measure of systematic, non-diversifiable risk? On the page, it talks about how beta is a measure of risk for a security compared to the overall market, which to me seems different than the risk of the overall market, which is how I interpret “systematic, non-diversifiable risk.” Can you help me understand this?
CFP Board Released Question
Which combination of the following statements about investment risk is correct?
- Beta is a measure of systematic, non-diversifiable risk.
- Rational investors will form portfolios and eliminate systematic risk.
- Rational investors will form portfolios and eliminate unsystematic risk.
- Systematic risk is the relevant risk for a well-diversified portfolio.
- Beta captures all the risk inherent in an individual security.
(1), (2), and (5) only
(1), (3), and (4) only
(2) and (5) only
(2), (3), and (4) only
Instructor Response:
Great question. Here’s the nuance — “market” in this context is an index that approximates the nature of the stock or client portfolio folio. For example, an S&P 500 stock would be compared to the S&P 500 index, not the entire “market.” Hence, beta measures only the volatility of a security relative to its index (market).
