Answer: Beta identifies the appropriate level of risk for which an investor should be compensated.

## Explanation **Option A is correct** because: - In CAPM, beta (β) measures systematic risk - the risk that cannot be diversified away - The security market line (SML) shows the relationship between expected return and systematic risk (beta) - Investors are only compensated for bearing systematic risk, which is measured by beta - The CAPM formula is: E(Ri) = Rf + βi × (E(Rm) - Rf), where beta determines the risk premium **Option B is incorrect** because: - Unsystematic risk IS diversifiable through portfolio diversification - Since unsystematic risk can be eliminated through diversification, investors are NOT compensated for taking on such risk - The statement incorrectly claims unsystematic risk is "not diversifiable" **Option C is incorrect** because: - According to CAPM, assets with equivalent betas should earn the same expected returns - The SML shows that all assets with the same beta lie on the same point on the line - If assets with the same beta earned different returns, it would create arbitrage opportunities **Key CAPM Concepts:** - Only systematic risk (measured by beta) is rewarded - Unsystematic risk can be eliminated through diversification - SML shows the linear relationship between expected return and systematic risk

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