In finance, the systematic risk of the market as a whole is commonly measured by which parameter?

Introduction / Context:
In investment analysis and portfolio management, risk is often divided into systematic risk and unsystematic risk. Systematic risk is the market wide risk that cannot be diversified away. The Capital Asset Pricing Model (CAPM) introduces a specific parameter to measure how sensitive a security or portfolio is to this market risk. Understanding this parameter is essential for finance interviews and exams.

Given Data / Assumptions:

• Systematic risk refers to the risk arising from broad economic and market factors, such as interest rates, inflation and economic growth, that affect many securities.
• The overall market portfolio is used as a benchmark for these movements.
• Individual securities may be more or less sensitive to market movements.
• CAPM uses a coefficient to capture this sensitivity.

Concept / Approach:
Beta is the measure that captures the sensitivity of a security or portfolio returns to movements in the market portfolio return. A beta of 1 indicates that the security tends to move in line with the market. A beta greater than 1 indicates higher volatility relative to the market, meaning the security amplifies market movements. A beta less than 1 indicates lower volatility. In CAPM, expected return is modelled as risk free rate plus beta times the market risk premium. Therefore, beta is widely described as the measure of systematic, non-diversifiable risk of an asset relative to the market.

Step-by-Step Solution:
Step 1: Recall that systematic risk is the portion of total risk that cannot be removed by diversifying across many securities. Step 2: Identify that CAPM describes the expected return of a security as: expected return = risk free rate + beta * (expected market return - risk free rate). Step 3: Understand that beta is defined as the covariance of the security return with the market return divided by the variance of the market return. Step 4: Recognise that this ratio shows how strongly the security co-moves with the market; a higher beta means higher exposure to market risk. Step 5: Conclude that beta is the standard measure of systematic market risk for a security or portfolio.

Verification / Alternative check:
Suppose stock X has a beta of 1.5, stock Y has a beta of 0.7 and the market has beta 1 by definition. If the market index rises by 10 percent, stock X on average might rise by about 15 percent and stock Y by about 7 percent, ignoring other effects. These differences in responsiveness reflect differences in systematic risk exposure. Analysts use beta to compare how risky stocks are relative to the market. A purely company specific event, such as a product recall, affects total volatility but does not change beta unless it changes how the stock responds to market movements. This practical use confirms beta as the measure of systematic market risk.

Why Other Options Are Wrong:
Option A, alpha, usually refers to the excess return of a security or portfolio over what CAPM predicts and is often interpreted as a measure of active manager skill, not systematic risk. Option C, gamma, is a Greek used mainly in options pricing to measure the rate of change of delta with respect to the underlying price, not market wide risk. Option D, all of the above, is incorrect because these parameters have different meanings. Option E, delta, measures sensitivity of an option price to changes in the price of the underlying asset, again not systematic market risk. Only option B correctly identifies beta as the standard measure.

Common Pitfalls:
A common mistake is to confuse total volatility with systematic risk. Beta captures systematic risk relative to the market, but a security can have high total volatility because of company specific events without necessarily having a high beta. Another pitfall is to treat beta as constant, when in reality it can change over time as the company business mix or leverage changes. In interviews, emphasise that beta measures how sensitive a security is to market wide movements and that it is the CAPM measure of systematic, non-diversifiable risk.

Final Answer:
The systematic risk of the market is commonly measured by beta, which shows how sensitive a security or portfolio is to movements in the overall market.