Beta measures a security's volatility relative to the overall market. Beta is used in the Capital Asset Pricing Model (CAPM) to calculate the expected return of an asset based on its risk relative to the market. A beta of 1 indicates that the security's price moves with the market, a beta greater than 1 indicates that the security is more volatile than the market, and a beta less than 1 indicates that the security is less volatile than the market.
What does a beta of 1 indicate about a security's volatility?
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Select an option above to see an explanation here.
A) A beta greater than 1 indicates that the security is more volatile than the market. B) A beta less than 1 indicates that the security is less volatile than the market. C) A beta of 1 indicates that the security's price moves with the market. D) Beta measures the security's volatility in relation to the market, not its independence.
Which type of risk can be reduced through diversification?
A) Market risk is a systematic risk affecting the entire market. B) Systematic risk affects the entire or large market segment and cannot be reduced through diversification. C) Unsystematic risk is specific to an individual security or company and can be reduced through diversification. D) Only unsystematic risk can be reduced through diversification.
In the Capital Asset Pricing Model (CAPM), what is used to calculate the expected return of an asset?
A) Alpha measures an investment's performance relative to its benchmark or market index. B) Beta is used in the Capital Asset Pricing Model (CAPM) to calculate the expected return of an asset based on its risk relative to the market. C) Standard deviation measures the dispersion of a set of data from its mean. D) Correlation measures the relationship between two variables.
In the 2008 financial crisis, many stocks experienced high levels of volatility, leading to increased beta values. Investors who had diversified portfolios with a mix of high and low beta stocks were better able to weather the storm, as their low beta stocks provided some stability during the market downturn.
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Example Series 65 Example Practice Question
An investor is considering adding a technology stock to their portfolio. The stock has a beta of 1.5, indicating that it is more volatile than the overall market. If the investor is looking to reduce their portfolio's overall risk, they may want to consider a stock with a lower beta.