ACCA Financial Management (F9) Certification Practice Exam

What does the beta factor measure in financial terms?

1. Market volatility

2. Systematic risk of a security

3. Portfolio diversification

4. Return on equity

The correct answer is: Systematic risk of a security

The beta factor is a crucial component in finance, particularly in the context of the Capital Asset Pricing Model (CAPM). It specifically measures the systematic risk of a security relative to the entire market. Systematic risk, also known as market risk, cannot be eliminated through diversification; it is inherent to the entire market or market segment. A beta of 1 indicates that the security's price movements are expected to mirror the movements of the overall market. A beta greater than 1 suggests that the security is more volatile than the market, meaning it tends to experience larger fluctuations. Conversely, a beta less than 1 indicates that the security is less volatile, with price movements that are smaller than those of the overall market. Understanding beta is essential for investors when assessing the risk-reward profile of a security, as it helps convey how much risk the investor is taking on in comparison to the anticipated market performance. This is why the beta factor is critically associated with systematic risk rather than market volatility (which is a more general term that may include both systematic and idiosyncratic risk), portfolio diversification (which refers to risk management strategies), or return on equity (which measures a company’s profitability).