Canadian Securities Course (CSC) Level 2 Practice Exam

What does standard deviation measure in the context of investments?

1. The excess returns because of investors' skills

2. The risk applied to portfolios or individual securities

3. The correlation within a portfolio

4. The difference between what is expected and what actually occurs

The correct answer is: The risk applied to portfolios or individual securities

Standard deviation is a statistical measure that quantifies the amount of variation or dispersion in a set of values. In the context of investments, it is primarily used to measure risk. Specifically, it helps investors understand how much the returns of an asset or portfolio can deviate from the average return over a specific period. A higher standard deviation indicates greater volatility and, therefore, a higher associated risk. Conversely, a lower standard deviation suggests that the returns are more stable and consistent relative to the average. This measurement is crucial for investors as it provides a way to gauge the uncertainty of potential returns. By understanding the standard deviation of an investment, investors can better assess the risk-reward trade-off and make more informed decisions regarding their portfolios.