Certified Management Accountant Practice Exam

What is the implication of a higher coefficient of variation?

1. Greater reliability of returns

2. Higher risk relative to expected return

3. Lower market volatility

4. Better portfolio diversification

The correct answer is: Higher risk relative to expected return

The coefficient of variation (CV) is a statistical measure that expresses the ratio of the standard deviation to the mean, typically used to assess the relative risk per unit of return. A higher coefficient of variation indicates that there is greater dispersion of returns relative to the expected return, which translates into a higher level of risk regarding the actual returns one might experience. When an investment has a high CV, it suggests that the returns fluctuate significantly compared to their average, indicating that the investment is riskier in relation to what an investor can expect to earn. Therefore, it implies a higher risk associated with the expected return, as investors could experience returns that are far below the average, or they might encounter large variances that could lead to losses. This characteristic is particularly crucial for investors who are trying to evaluate potential investments, as it helps assess whether the potential return justifies the level of risk they are taking on. Understanding this measure can guide investment decisions and help in creating a balanced portfolio that aligns with individual risk tolerance.