Beta is a value that measures the volatility of security relative to the market. It shows how a stock changes when there are changes in the market.
Where is beta used?
Beta is used for CAPM (Capital Asset Pricing Model). CAPM describes the relationship between systematic risk and expected return for stocks. It is used to calculate the expected returns based on the risks and the cost of capital. It provides the investor only an estimate of how much risk the stock will add to the portfolio.
How to calculate beta?
A beta coefficient measures the volatility of an individual stock compared to the systematic risk of the entire market. It represents the slope of the line through a regression of data points. These data points show individual stock’s returns against those of the market as a whole.
Beta is represented as:
Beta coefficient (β) = Covariance (Re, Rm)/ Variance (Rm)
In this equation,
Re= The return on an individual stock
Rm= The return on the overall market
Covariance= How changes in a stock’s returns are related to changes in the market’s returns
Variance= How far the market’s data points spread out from their average value
What is beta in stocks?
It measures the expected changes in a stock relative to movements in the market. If the beta coefficient is greater than 1, it means that the stock is more volatile than the market. If beta less than 1, it indicates that the stock has lower volatility than the market. It is a component of CAPM that calculates the cost of equity funding. Beta is of limited value when making stock selections. Beta is a better indicator of short-term rather than long-term risk.
What is beta in finance?
A company with high beta, give high returns but also has high risks.
β <1>0 – Less volatile than the market
β =0 – Stock uncorrelated to the market. Stocks that have no associated risks have a beta value of 0. Examples of government bonds, fixed deposits, and cash.
β <0 – The stock is inversely proportional to the market. Example of this stock is gold.
β =1 – The stock is related to the market and has the same volatility as of the market
β >1 – The stock is more volatile than the market