Uniform Combined State Law (Series 66) Practice Exam 2025 – Your All-In-One Guide to Exam Success!

In the Capital Asset Pricing Model (CAPM), risk is defined in terms of the deviation of returns, which measures how much the returns on an asset can vary from its expected return. This deviation is often referred to as volatility or standard deviation. The CAPM specifically uses this notion of risk to calculate the expected return on an investment, which is based on the risk-free rate, the expected market return, and the asset's systematic risk, commonly represented by beta.

This focus on deviation in returns highlights the unpredictable nature of investment performance due to various market factors. In CAPM, it is essential to differentiate between systematic risk (market risk) and unsystematic risk (specific to a company or industry); the model primarily deals with systematic risk, which influences how an asset correlates with market movements.

Understanding risk as a deviation of returns helps investors assess the potential for variance in their investments and make informed decisions about the expected rewards relative to the risks they are taking on. This fundamental understanding aligns with the model's purpose of providing a framework for evaluating the trade-off between risk and return in the context of a well-diversified portfolio.