Question

Define the following terms, using graphs or equations to illustrate your answers wherever feasible: d. Characteristic line; beta coefficient,

Answer 1

Characteristic line

A Characteristic line is a straight line which is formed by the using the concept of regression analysis that help to summa rise a particular security which indicate systematic risk and the rate of return , the Characteristic line is also called security Characteristic line (SCL)

Characteristic line is created by plotting a security return at various points on the graph X-axis shows market return in access of risk free rate and on Y-axis , It measures the access return of the security.

The characteristic line present a visual representation to show how a specific security perform when compare to the performance of the market taking as a whole.The return and co-related risk relative to the market in general represented by both the slope of Characteristic line and its standard deviation.

The Characteristic line is a part of wider security and market performance assessment tool which is known as modern portfolio theory (MPT) , Under this through the regression line other qualities os security can be plotted and help investor to measure the risk and make decision in future.

According to MPT and CAPM , rates of return should increase as the risk ness of the asset increases , it clearly shows that as the risk increases return goes up and if risk falls or any business not taking risk return will fall accordingly. So, we can say that there is variability of the return.  

Beta Coefficient

In the finance, the beta or beta coefficient of an investment is a measure of the risk arising from the general market movements compared to the basic ideal factors.

it is to be observed that ideal beta capacity for the market is considered to be 1, if having factor less than 1 then it is observed that it not relate to the market conditions for investment purpose and not to go for that investment as not supported and also price movement not correlated with the market environment.

A beta greater than 1 considered to be good for the investment purpose and the assets may be move up or down with the market.

Example: IF THE COMPANY HAVE more advanced technology it will benefit for the investment as beta is negative and possible for the investment that tends to go down when ever the market goes up an if the beta is positive than reverse process is adopted.

Beta is important it measure the risk regarding investment and cannot be reduced by the diversification. it does not measure the risk investment. In the capital assets pricing model (CAPM) , beta risk is the only risk that for which investor should receive higher return than the risk-free rate of interest.