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Beta measures volatility relative to the market. It measures how volatile a stock is in relation to changes in the market.
CAPM (Capital Asset Price Model) uses beta. CAPM is a model that shows the relationship between stock returns and systematic risk. It calculates the expected returns using capital costs and risks. It gives the investor an estimate of the risk that the stock may pose to their portfolio.
Beta coefficients are used to measure volatility relative to market risk. It is the slope of the line calculated by a regression of data points. These data points compare the returns of individual stocks with those of the entire market.
Beta can be represented by:
Beta coefficient (b), = Covariance, Re, Rm/ Variance (Rm).
This equation is:
Re= The return on an individual stock
Rm = The return on the total market
Covariance = How changes in stock returns relate to market returns
Variance = The spread of market data points from their average value
It is a measure of the stock's expected changes relative to market movements. Beta coefficient greater than 1 indicates that the stock is more volatile relative to the market. Beta less than 1 indicates lower volatility than the market. It is an integral part of CAPM which calculates the cost for equity funding. When making stock selections, beta is only of limited value. Beta is a better indicator for short-term than long-term risks.
High beta companies can offer high returns, but also have high risk.
b 1>0 -- Less volatile than market
b =0 – Stock that is not correlated with the market. Beta value for stocks without associated risks is 0. You can find examples of fixed deposits, government bonds, and cash.
b 0 = The stock is ininversely proportional the market. Gold is an example of such a stock.
b =1: The stock is closely related to the market, and has the same volatility like the market
b >1: The stock is more volatile that the market
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