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Beta

Reviewed by Vineeth | Updated on Oct 05, 2020

Catalogue

Introduction

The term ‘beta’ is extensively used in investments, particularly in capital markets. It is used in the capital asset pricing model (CAPM). Beta is a measure of the systematic risk or market volatility of a portfolio or specific security against the benchmark or market in general.

Breaking Down Beta

For instance, the coefficient of beta may measure the volatility of an individual stock in comparison with the unsystematic risk of the market as a whole. In statistics, beta will represent the slope of the line via regression of data points through an individual share’s returns against that of the benchmark or market.

Beta is made use of in the capital asset pricing model (CAPM). It represents the relation between the expected returns on a given capital asset and the systematic risk of shares in particular.

The CAPM is extensively used almost everywhere in the finance world for pricing securities that are risky and providing anticipated returns for capital assets when given with the risk of the cost of capital and assets.

The formula to calculate the co-efficient of beta is as given below:

Beta coefficient = {covariance (Re,Rm)} / {variance (Rm)}

The terms in the formula above are explained below: Re is the return on an individual stock Rm is the returns recorded in the overall market Covariance shows how the changes in the market effect return of stocks The variance shows how the market data points are spread from their mean value

Beta and Investors

Beta might offer useful data for evaluating stocks, but it does have limitations. Beta is made use of in obtaining short-term risk of a security. It is also used to analyse volatility trends to determine the cost of equity through CAPM. Nevertheless, as beta is obtained through historical data points, it would not be of use for investors wanting to forecast its movements.

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