Question

Explain all in detail and support your argument using the financial concepts that are consistent with the book.

Make distinctions between the standard deviation and beta in the measurement of risk in the capital market. Which one of these two metrics (standard deviation and beta) is relevant for measuring the risk of well-diversified portfolio? Explain why.

Answer 1

Risk contains two parts.

1. Systematic Risk

2. Unsytematic Risk

Systematic Risk - It is also called as Market Risk and common for all organizations in the industry. This risk is at macro level and can't be controlled.

Unsystematic Risk - It is also called as firm specific risk. It can be controlled through proper diversification strategy. Invest in securities having correlation"-1". Then by investing at particular weights, we can reduce the risk to "Zero".

In the given case, Portfolio is well diversified. Hence market risk is relevant. As Unsystematic risk is reduced through diversification strategy.

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