A measure of “risk per unit of expected return.”
A. standard deviation
B. coefficient of variation
C. correlation coefficient
Answer Explanation for Question: A measure of “risk per unit of expected return.”
The coefficient of variation (CV) is a statistic that indicates how widely data points in a series are distributed around their mean. Coefficient of variation is the ratio between the standard deviation and the mean, and it’s a useful statistic for comparing the degree of variation between two data series, even if the means are dramatically different.
The coefficient of variation plays an important role in investment selection in finance. A financial metric represents the risk-to-reward ratio, where the volatility represents the risk and the mean represents the reward of an investment.
By analyzing the coefficient of variation of different securities, an investor is able to identify the risk-to-reward ratio of each security and develop an investment strategy. An investor generally seeks a security with a low coefficient (of variation) since it provides a high risk-to-reward ratio and low volatility. When the average expected return is below zero, the low coefficient is not favorable.
Investors who are risk-averse might choose assets with historically low volatility in relation to returns, relative to the overall market or industry. Risk-seeking investors, on the other hand, might seek out assets with a high volatility history.