What is beta a measure of?

• A. Systematic risk relative to the market; it indicates sensitivity of a security's returns to market moves
• B. Unsystematic risk unique to a company
• C. Liquidity risk
• D. Historical average return

Answer: (A)

Beta measures systematic risk, the portion of a security’s risk that comes from market-wide factors. It tells you how much the security’s returns tend to move with the market. If beta is about 1, the asset tends to move with the market; if it’s greater than 1, it’s more volatile than the market; if it’s less than 1, it’s less volatile. This matters because diversifying can remove unsystematic (company-specific) risk, but systematic risk remains, and beta captures how exposed a security is to that remaining market risk. In practice, beta is used in the Capital Asset Pricing Model to estimate expected returns: expected return equals the risk-free rate plus beta times the market risk premium. It’s calculated as the covariance of the asset’s returns with the market’s returns divided by the variance of the market’s returns, using a chosen market index and time period. Beta reflects sensitivity to market moves, not liquidity risk, not a company’s unique risk, and not the historical average return.