Which statement best describes what beta measures in CAPM?

• A. Sensitivity to market moves.
• B. Liquidity risk.
• C. Currency risk.
• D. Credit risk.

Answer: (A)

Beta in CAPM measures how a security’s returns respond to the overall market. It captures the sensitivity to market moves, i.e., the portion of a security’s risk that comes from market-wide factors rather than firm-specific factors. In formula form, the expected excess return is tied to the market risk premium multiplied by beta, so a beta of 1 means the security tends to move with the market, greater than 1 means amplified moves, and less than 1 means smaller moves. This focus on market-driven movements distinguishes beta from liquidity risk, currency risk, or credit risk, which are separate risk types not represented by beta. To estimate beta, you typically regress the security’s returns against the market’s returns; the slope of that regression is the beta.