Beta:
The Beta is the slope of the characteristic regression line. Beta is a measure of a stock's volatility in relation to the market. It reveals the relative movement of any stock values in relation to movement in the market. In other words, beta describes the relationship between the stock’s return and index return. Beta values provide details about the risky ness of the stock in the portfolio and help the fund manager in timely restructuring of portfolio.
Uses of Beta:
Using beta to measure volatility, investor can better choose those securities that meet their criteria for risk. Investors who are very risk averse should put their money into investments with low betas such as utility stocks and Treasury bills. Those investors who are willing to take on more risk may want to invest in stocks with higher betas.
The value of beta can be computed using a simple regression (if large numbers of observations are available) or the rise-over-run method is used (if only small numbers of observations are available).
Interpretation of Beta:
- Beta = + 1.0:- One percent change in market index return causes exactly one percent change in the stock return. It indicates that the stock moves in tandem with the market.
- Beta = + 0.5:- One percent change in market index return causes 0.5 percent change in the stock. The stock is less volatile compare to the market.
- Beta = + 2.0:- One percent change in market index return causes 2 percent change in the stock. The stock return is more volatile. The stock more than 1 beta value is considered to be risky.
- Negative Beta: - Negative beta indicates that the stock moves in the opposite direction to the market return. Stocks with negative beta value resist the decline in the market return. The stocks with negative returns are very rare.
