Question

d. Obtain a beta estimate for your company. What does it mean? Examine and compare the annual total returns and average return of your stock with that of the S&P500’s returns. Did it follow the Beta estimate? It would be helpful to illustrate the returns of the company’s stock and the market. in general how would we compare beta and returns? what would we say if returns higher or lower than the s&p 500?

Answer 1

Beta: -

Beta is used for assessment of Risk associated with company or its stock. In other words Beta is ratio of co variance of Security with the Market.

Formulas

Beta of an Asset or Security = Co variance between Security and Market / Variance of the market

Or

Change in return of security / Change in return of market

Meaning of obtaining Beta estimate of company

It means to know risk associated with the company. It show sensitivity of company with market variance.

When Security has Beta Greater than 1:

It shows asset/company/share has a higher volatility than the market. Fluctuation in asset/company/share price will be more fluctuation in the market index. It is termed as High Beta Security

Example: A asset/company/share with a beta of 3.0 will tends to move thrice as much as the market. If the market went up by 1%, the Security tends to rise by 3%. If the market fell by 1%, the Security tends to fall by 3%.

A Security with Beta Less than 1

It means asset/company/share has a lesser volatility than the market. Fluctuation in asset/company/share price will be less than fluctuation in the market index. It is termed as Low Beta Security

Example: A Security with a beta of 0.5 will move half as much as the market. If the market rises by 20%, the Security tends to rise by 10%. If the market fell by 20%, the Security tends to fall by 10%.

A Security with Beta Equal to 1

It means volatility in asset/company/share price & market is same. Security price are expected to move in tandem with the market. It is termed as Normal Security.

For Example: In case a security beta is 1 than If the market moved up by 20%, the Security will also tend to move up by 20%. If the market fell by 20%, the Security will also tend to fall by 20%.

A Security with Beta is less than 0 [ Negative Beta ]

Beta value less than zero indicates that a negative relationship between security return and market return exists. i.e If market goes up price of the security will fall and vice versa.

Security with Betas = 0 [ Zero Beta ] :

If beta value is zero it means there is no systematic risk and the security prices have no relationship with the market. In reality beta value can hardly take a zero value. However Beta of Risk Free Security is assumed to be zero.

Company: - Amazon

Current Beta:- 1.71

Its Beta is above 1 it means it has a higher volatility than the market. If market moves 10 % it will move 17.1 %.

Comparison Between Beta and Return

Return of Security= Risk Free Return +Beta (Market Return-Risk Free Return)

It means security earn above or lower than risk free return depends on its Beta.