Beta is the only metric of risk needed to estimate the expected return of an asset, as it captures all systematic and unsystematic risk of the asset.

Question

BlackTom AI · Accepted Answer

The statement under examination is: 'Beta is the only metric of risk needed to estimate the expected return of an asset, as it captures all systematic and unsystematic risk of the asset.'
Option 1: True. Interpreting this as a claim that beta alone suffices to estimate expected return and encompasses both systematic and unsystematic risk is problematic. Beta measures systematic risk relative to the market and is used in the Capital Asset Pricing Model (CAPM) to estimate the risk-premium component of expected return. It does not capture unsystematic (idiosyncratic) risk, which is specific to an individual asset and diversifiable in a portfolio. Therefore, the claim overstates beta’s scope and is not accurate.
Option 2: False. This option correctly identifies the issue: beta captures only systematic risk (the asset’s covariance with the market) and neglects unsystematic risk. Since investors can diversify away unsystematic risk, beta remains a central input for pricing under CAPM, but it does not account for all risk types. Other risk considerations, such as liquidity risk, model risk, or factors beyond market risk that might affect expected returns, are not encompassed by beta alone. Consequently, the assertion that beta captures all risk and is the sole metric needed is incorrect.
In summary, evaluating the claim reveals that beta does not cover unsystematic risk, and relying on it alone is insufficient for estimating all aspects of an asset’s risk and expected return.

COMM_V 298 201-207 2024W2 COMM 298 2024W2: Final Extra Practice

Beta is the only metric of risk needed to estimate the expected return of an asset, as it captures all systematic and unsystematic risk of the asset.

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