Question

In: Finance

Choose to write a one-page short essay on one of the following topics: 1. What is...

Choose to write a one-page short essay on one of the following topics:

1. What is BETA? Provide examples of why investors should pay attention to a stock's beta.
2. Read about the Optimal Portfolio on an investing website like Investopedia or Wikipedia. Should every optimal portfolio contain some amount of the “riskless asset” as indicated by the theory?

Solutions

Expert Solution

Beta is a relative measure of risk: the risk of a single security relative to the market portfolio of all securities. Beta is also known as financial elasticity or related relative volatility and may be referred to as a measure of the sensitivity of the asset's returns to market performance, it is non-diversifiable risk. Beta is calculated using regression analysis and is considered to be the tendency of a stock's returns to respond to market changes. Beta is useful for comparing the relative systematic risk of different securities and, in practice, it is used by investors to judge the risk of a security. The beta of the shares is less than 1, which means that the shares are not very market related. In terms of price movements, a beta of less than 1 indicates that the stock is less volatile, i.e. less responsive to price movements in the general market. Beta stock more than 1: means that the stock is not very correlated to the market. However, unlike a beta of less than 1, this means that a stock is more volatile (i.e. more responsive to price movements in the broader market). The beta of the shares is negative (less than 0): it means that a share is inversely proportional to the market. The trend of the stock is to move in the opposite direction of the market. If the negative number is greater, the stock is more volatile. The shares can be classified according to their beta. Since the change in the market is constant for all securities during a given period, classifying securities based on beta is equivalent to classifying them based on their absolute systematic risk. High beta stocks are said to be high risk stocks.

The beta coefficient describes how the expected return of a security or portfolio is related to the performance of the financial market as a whole. The beta coefficient was born from the analysis of linear regression. It is linked to a regression analysis of the returns of a portfolio (such as an equity index) (x-axis) in a specific period compared to the returns of a single asset (y-axis) in a specific year. The regression line is then called the safety feature line (SCL) and both the alpha and beta coefficients of an asset play an important role in modern portfolio theory. For example, in a year when the benchmark or broad market index returns 25% above the risk-free rate, let's assume that two managers earn 50% above the risk-free rate, by since this In theory, it is possible to achieve higher performance simply by taking a leverage in the large market to double the beta, making it exactly 2.0, we would expect a portfolio manager to have built the portfolio with a performance greater than a beta slightly less than 2 of so that the excess return not explained by the beta is positive. one beta average of 3.0 and the other with a beta of just 1.5, so CAPM simply states that the additional manager's additional performance is not enough to compensate us for that manager's risk, while the second manager did more than expected given the risk.


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