Question

How to calculate beta from a number of stocks

Answer 1

SOLUTION:

BETA:

- Beta is a kind of measure to determine the volatility of an asset or portfolio in relation to the overall market.

- The overall market has a beta of 1.0,

- Individual stocks are ranked according to how much they deviate from the market.

- A stock that swings more than the market over time has a beta greater than 1.0.

- If a stock moves less than the market, the stock's beta is less than 1.0.

- High-beta stocks tend to be riskier but provide the potential for higher returns.

- Low-beta stocks pose less risk but typically yield lower returns.

- Beta is often used as a risk-reward measure.

- Beta helps investors determine how much risk they are willing to take to achieve the return for taking on that risk.

HOW TO CALCULATE BETA:

Beta =   

where,

Covariance = Measure of a stock’s return relative to that of the market

Covariance measures how two stocks move together. A positive covariance means the stocks tend to move together when their prices go up or down. A negative covariance means the stocks move opposite of each other.

Covariance is used to measure the correlation in price moves of two different stocks.

Variance = Measure of how the market moves relative to its mean​.

Variance refers to how far a stock moves relative to its mean.

Variance is used in measuring the volatility of an individual stock's price over time.

FOR EXAMPLE:

An Investor is looking to calculate the Beta of ABC as compared to XYZ.

Corelation between ABC and XYZ is 0.78.

ABC's Standard Daviation of Returns is 24.85%

XYZ's Standard Daviation of Returns is 35.47%

Beta of ABC =   

= 0.5422

ABC would be considered less volatile than XYZ, as its beta of 0.5422 indicates the stock theoretically experiences 46% less volatility.