What is the sum of market risk and diversifiable risk, known as total risk, equivalent to_______________?
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Answer: D. Variance
Explanation
Total risk, encompassing both market and diversifiable risk, is measured by the variance of returns. Statistical variance quantifies the spread of actual returns around the expected average outcome. Combining systematic and unsystematic risk components yields the aggregate total risk of an asset. Market risk affects all securities within an economy, whereas diversifiable risk is company-specific. Portfolio diversification eliminates unsystematic risk, leaving only systematic market risk behind. Variance and standard deviation serve as the primary statistical metrics for measuring investment risk.
Portfolio managers analyze return variances to assess the overall risk profile of mutual fund holdings. Quantitative analysts rely on variance calculations when constructing modern mean-variance efficient portfolios. Corporate risk officers monitor earnings variance to maintain financial stability and credit ratings. Sharpe’s alpha measures risk-adjusted excess performance rather than aggregate total risk variance. Standard alpha’s is an incorrect grammatical phrasing that does not represent financial statistics. Alpha’s variance measures the volatility of excess returns rather than total asset return variance.
- Subject
- Accounting and Finance
- Category
- Finance
- Topic
- —
- Difficulty
- medium
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