Practice Quiz

FRM Financial Risk Manager Practice Test

Category - The Capital Asset Pricing Model

Start a Study Session Sign up for Question of the Day
Beta provides a measure of the "systematic risk" of the portfolio. This is the part of the risk that cannot be diversified away. Given that the portfolio risk is measured by its covariance, why are investors still willing to hold assets with lower expected returns?
  1. Assets with low expected returns now can yield higher returns in the future.
  2. Investors do not have any other better alternatives.
  3. Although these assets have low expected returns, they are less risky due to low overall systematic risk.
  4. Low expected returns attract less investors, so it is difficult to sell them.
Explanation
Although these assets have low expected returns, the low betas means together they can considerably reduce overall systematic risk. The β of an asset measures its relative impact on the systematic risk of the portfolio as a proportion of the total variance of the portfolio. Assets therefore with low betas are willingly held despite their low expected returns because they considerably reduce overall undiversifiable (systematic) risk in equilibrium.

Key Takeaway: In short, adding a lower return asset can improve the portfolio’s risk profile.
Previous Next
Was this helpful? Upvote!
Login to contribute your own answer or details
Start a Study Session Sign up for Question of the Day

Top questions

Related questions

Most popular on PracticeQuiz