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Beta represents the relation between the change of the market and the change in the stock price.
BETA:
Measures a stock’s market risk, and shows a stock’s volatility relative to the market. In other words, it measures the sensitivity of a stock’s returns to changes in returns on the market portfolio. Indicates how risky a stock is if the stock is held in a well-diversified portfolio. It’s an index of system. The beta for a portfolio is simply a weighted average of the individual stock betas in the portfolio.
Beta can be calculated using the following equation:
Β = [Cov(Ri,Rm)] = ρi,m σi
σ2m σm
Where [Cov(Ri,Rm)] and ρi,m are the covariance and correlation between the asset and the market, and σm and σi are the standard deviations of asset returns and market returns. The theoretical average beta of stocks in the market is1. A beta of zero indicates that a security's return is uncorrelated with the returns of the market.
If beta =1.0, the security is just as risky as the average stock.
If beta >1.0, the security is riskier than average.
If beta <1.0, the security is less risky than average.
Most stocks have betas in the range of0.5 to1.5.
If the correlation between Stock i and the market is negative (i.e., ρi,m <0) then the beta of a stock can be negative. However, a negative beta is highly unlikely.
Dear Mr. Ahmed Migabry,
Thank You for asking me to answer the Qestion. The following is the answer of your Qestion.
The capital asset pricing model is used for calculating the cost of equity (Ke). This model assumes that overall change in the stock market will affect investors investments. Some investments are very sensitive to Stock Market Downturns and the sensitivity of investments to stock market downturns is calculated by using the average fall in the return on a share each time, there is a1% fall in the stockmarket as a whole; this is called a beta factor.
This Beta Factor is not constant and is dependent upon the amount of RISK.
Low Risk: beta <1.0
Moderate Risk: beta =1.0
High Risk: beta >1.0
Thanks and Regards:
Gohar Ayub
Beta is a key component for the capital asset pricing model (CAPM), which is used to calculate cost of equity,
All things being equal, the higher a company's beta is, the higher its cost of capital discount rate. The higher the discount rate, the lower the present value placed on the company's future cash flows. In short, beta can impact a company's share valuation.
Beta can be referred to as a measure of the sensitivity of the asset's returns to market returns.
The formula for the beta of an asset within a portfolio is :
ra : measures the rate or return of the asset,
rb : measures the rate of return of the portfolio benchmark,
cov(ra,rb) is the covariance between the rates of return.
The portfolio of interest in the CAPM formulation is the market portfolio that contains all risky assets, and so the rb terms in the formula are replaced by rm, the rate of return of the market.
From the above formula you can see that beta is not stable since it debends on other variables.
As far as the stability of beta goes, one needs to evalute the many factors surrounding any project and calculate the beta periodically. It is imporant to come up with an accurate cost of capital. No wonder real-life projects all over the world run over budgets.
The beta, also known as systematic risk, measures the volatility. In other words, it is used to determine the price fluctuations of a stock, or a portfolio in relations with the whole market.
In graphical language, it is the slope of the characteristics line between returns for the stock (or portfolio) and those for the market as whole.
In CAPM model, the expected return for a stock or portfolio is the risk free rate plus a premium for systematic risk based on beta.
R(stock/portfolio) = R(risk-free rate) + (R(market)-R(risk-free rate))*Beta
as it measure the variability, so it is not stable.
