In investment and portfolio theory, standard deviation of returns is used to measure which type of risk of a security or portfolio?

Introduction / Context:
Risk measurement is a core concept in investment and portfolio management. Standard deviation of returns is one of the most widely used statistical measures of risk. This question asks which type of risk standard deviation measures. To answer correctly, you need to distinguish between total risk and its components, systematic and unsystematic risk.

Given Data / Assumptions:

• We are analysing returns of a single security or a portfolio.
• Standard deviation is calculated from a series of historical or expected returns.
• Risk can be decomposed into systematic non diversifiable and unsystematic diversifiable components.
• The question wants to know what standard deviation as a measure actually captures.

Concept / Approach:
Standard deviation measures the dispersion of returns around the mean. It reflects how much actual returns tend to deviate from the expected or average return. This dispersion comes from all sources of uncertainty affecting the security, including both systematic risk (market wide factors such as interest rates, inflation, and economic growth) and unsystematic risk (company specific factors such as management decisions or product failures). Therefore, standard deviation is a measure of total risk. To isolate systematic risk only, other measures such as beta are used. Non diversifiable risk and systematic risk are related concepts that represent only part of total risk, not the entire variation captured by standard deviation.

Step-by-Step Solution:
Step 1: Recall that total variance or total standard deviation of returns includes all sources of variability.Step 2: Understand that total risk can be decomposed into systematic risk plus unsystematic risk.Step 3: Recognise that standard deviation itself does not separate these components; it measures the overall variability of returns around the mean.Step 4: Compare the options. Option D states that standard deviation measures total risk, including both systematic and unsystematic components.Step 5: Conclude that option D is correct and that options A, B, and C are too narrow because they refer only to specific parts of risk.

Verification / Alternative check:
In portfolio theory, the variance of a well diversified portfolio tends to approximate systematic risk because unsystematic risk is diversified away. However, for a single security or a non diversified portfolio, standard deviation reflects both systematic and unsystematic risk. Textbooks explicitly define risk as the standard deviation of returns and then explain that this is total risk. Other measures like beta are introduced to capture systematic risk alone. This confirms that standard deviation is a total risk measure, consistent with option D.

Why Other Options Are Wrong:
Option A non diversifiable risk only refers to systematic risk, but standard deviation without additional analysis does not separate systematic from unsystematic risk. Option B economic risk only is too vague and ignores company specific variability. Option C systematic risk only would be correct for beta, not for standard deviation. Therefore, these options do not correctly describe what standard deviation measures.

Common Pitfalls:
Students sometimes confuse beta and standard deviation, thinking both measure the same type of risk. Others assume that because diversified portfolios mainly face systematic risk, standard deviation must always represent only that component. To avoid such errors, remember that standard deviation is a broad measure of dispersion, while beta is a relative measure of market related risk. When asked in general, standard deviation measures total risk.

Final Answer:
Standard deviation of returns measures the total risk of a security or portfolio, including both systematic and unsystematic components.