Advanced Diploma of Financial Planning (ADFP) Practice Test

Which measures of risk relate to volatility?

1. Beta and interest rate

2. Standard deviation and beta

3. Liquidity and volatility

4. Return on investment and beta

The correct answer is: Standard deviation and beta

The correct choice is based on the understanding that both standard deviation and beta are key measures that relate to volatility in the context of investment risk. Standard deviation quantifies the dispersion of returns around the mean return of an investment. A higher standard deviation indicates greater volatility, which means that the investment's returns fluctuate widely, leading to a higher level of risk. Investors often use standard deviation as a statistical measure to assess the historical volatility of a security's returns, helping them understand the potential price variability over time. Beta, on the other hand, measures the sensitivity of an investment's returns to the returns of the market as a whole. It essentially indicates how much the price of a security would be expected to move in relation to movements in the broader market index. A beta greater than 1 suggests the investment is more volatile than the market, while a beta less than 1 indicates it is less volatile. Consequently, beta helps investors identify the systematic risk associated with an investment in relation to market movements. The other options include terms that either do not directly relate to volatility (like interest rate in the first choice, which influences but does not measure volatility) or mix measures that do not align with volatility risk, such as liquidity and return on investment which pertain to