Beta()

Definition:
The beta coefficient is the relative measure of sensitivity of an assets return to change in return on the market portfolio
It can be viewed as an index of the degree of responsiveness of the securities returns with the market return.

 Calculation
The beta coefficient , is calculated by relating the returns of a security with the returns for the market Mathematically, the beta of security is the securitys Co - Variance with the market portfolio divided by the variance of the market portfolio.

When, > 1 = The security is more risky < 1 = The security is less risky

t <0

=0

Interpretation Asset generally moves in the opposite direction as compared to the index Movement of the asset is uncorrelated with the movement of the benchmark

Example A short position Fixed-yield asset, whose growth is unrelated to the movement of the stock market

0<<1

Stable, "staple" stock such as a Movement of the asset is company that makes soap. Moves in generally in the same direction the same direction as the market at as, but less than the movement large, but less susceptible to day-toof the benchmark day fluctuation. Movement of the asset is generally in the same direction as, and about the same amount as the movement of the benchmark Movement of the asset is generally in the same direction as, but more than the movement of the benchmark A representative stock, or a stock that is a strong contributor to the index itself. Volatile stock, such as a tech stock, or stocks which are very strongly influenced by day-to-day market news.

=1

>1

Illustration:
The following information is available in respect of a security, S and a market portfolio M Probability Return S M
o.3 0.4 0.3 10 16 32 11 20 19

Find out of the security.

In order to calculate of the security, various figures have been calculated and summarised as follows:

S
Average Expected return St. Deviation Variance
19%

M
17%

.089 .00792

.0395 .00156 .00204

= 1.3

Classification of Beta
Portfolio Beta
Project Beta

Geared Beta
Ungeared Beta

Proxy Beta
Fundamental Beta

Portfolio Beta
It is used in context of general equities. The B of a portfolio is the weightage sum of the individual asset betas according to the proportions of the investments in the portfolio. Eg. - If 50% of the money is invested in stock A with a beta of 1:00 and 50% money is in B with a beta of 2, the portfolio beta is 1.50. Portfolio beta describes relative volatility of an individual security portfolio, taken as a whole, as measured by the individual stock betas of the security. A beta of 1.50 relative to the S & P 500 implies that if S & P excess return increases by 10% the portfolio is expected to

A measure of the portfolio volatility

A beta of 1:00 means that the portfolio is neither more nor less volatile or risky than the wider market. A beta of more than 1:00 indicates greater valatility while a beta of less than 1:00 indicated less. Eg. A portfolio consists of two securities, one valued at Rs. 15,000 and having a beta of 0.9 and the other valued at Rs. 10,000 having a beta of 1.5, the portfolio beta is;
= 1.14

Project Beta
It basically studies the systematic risk factor of any project. It measures the risk associated with ascertain project. It is a part of capital budgeting decisions. It is a measure of sensitivity.

Eg. A company is starting a project. In order

to judge the sensitivity of the project the

project beta will be calculated.

Geared beta
An indication of the systematic risk attaching

to the returns on ordinary shares. It equates

to the asset beta for an ungeared firm or is adjusted upward to reflect the extra riskiness of shares in a geared firm, i.e. geared beta. In the CAPM, it is relevant measure of total equity risk known as geared beta. It is very well related to debt concept.

Ungeared Beta
The asset beta or corporate beta, or business beta, is a measure of the business risk in a sector; that is the business risk alone. Unaffected by any financial risk that would be introduced by debt financing on the balance sheet Each Business sector has its own unique risks and so each business sector will have its own asset beta. It is not possible to convert an asset beta from one sector into an asset beta for another sector; Each sectors asset beta has to be derived from statistical analysis(Using Least

Since the Asset beta reflects purely business risk, a company with only equity finance on its balance sheet will find that its equity beta is the same as the sectors asset beta. This is because the company has no debt finance and so does not exposed its shareholders to the financial risk associated with debt finance, hence the asset beta is also called an ungeared equity beta.

Equity Beta:
It measures the systematic business risk and financial risk of a company. Asset beta measures the systematic business risk only.

Systematic Risk
They reflects to macro economic factors and cannot be diversifies.

Unsystematic Risk

Asset beta is a model of what a corporate stock's volatility would be if it had no debt, relative to the market.

or the shortcut

And

Fundamental Beta:
The product of a statistical model to predict the fundamental risk of the security using not only price data but other market related financial data

Proxy Beta:
It is used when the firm has no market listing and thus no beta of its own. It is taken from a comparable listing firm, and adjusted as necessary for relative financial gearing levels, Hence Proxy Discount rate

Formula:

Problem
The following information is available: Expected Return Standard Deviation Coefficient of Correlation

Stock A 16%
15%

Stock B 12%
8% 0.6

(a)What is the covariance between Stock A and Stock B (b)What is the expected return and risk of a portfolio in which A and B have weights of 0.6 and 0.4

SOLUTION:
(a) = 0.60 X15X8

= 72
(b)

Expected Return = 0.6 X16+0.4X12 = 14.4%

Risk

=
= [0.62X225+0.42X64+2X0.6X0.4X72]1/2

= 11.22%