Beta measures a stock's volatility, the degree to which its price fluctuates in relation to the overall stock market. In other words, it gives a sense of the stock's risk compared to that of the greater market's. Beta is used also to compare a stock's market risk to that of other stocks. Analysts use the Greek letter 'ß' to represent beta.
Full Answer
What happens if the beta of a stock is 1?
If a stock has a beta of 1, it will move in the same direction as the index, by about the same amount. An index fund that mirrors the S&P 500 will have a beta close to 1.
What is the beta coefficient of the market?
If a beta coefficient is 1.7, that implies the return on the stock tends to be less volatile than the return on the market. True A portfolio's beta coefficient tends to be stable over time. True During a rising market, stocks with greater beta coefficients may be preferred. True The numerical value of beta for the market equals 1. True
When to use industry beta to estimate cost of capital?
The decision to use the industry or firm beta to estimate the cost of capital depends on: how small the estimation errors are of all betas across industries. how similar the firm's operations are to the operations of all other firms in the industry.
What is the beta of a company with high or low beta?
pre-tax cost of debt. after-tax cost of debt. None of these. low beta if sales are highly dependent on the market cycle. high beta if sales are highly dependent on the market cycle.
What does it mean when a stock has a beta of over 100?
If you see a beta of over 100 on a research site it is usually a statistical error or the stock has experienced a wild and probably fatal price swing. For the most part, stocks of established companies rarely have a beta higher than 4.
What does beta mean in investing?
In investing, beta does not refer to fraternities, product testing, or old videocassettes. Beta is a measurement of market risk or volatility. That is, it indicates how much the price of a stock tends to fluctuate up and down compared to other stocks.
What Is the Beta?
The value of any stock index , such as the Standard & Poor's 500 Index, moves up and down constantly. At the end of the trading day, we conclude that "the markets" were up or down. An investor considering buying a particular stock may want to know whether that stock moves up and down just as sharply as stocks in general. It may be inclined to hold its value on a bad day or get stuck in a rut when most stocks are rising.
Why should gold stocks have negative beta?
Some investors argue that gold and gold stocks should have negative betas because they tend to do better when the stock market declines.
Why is beta important?
Using beta to understand a security's volatility can help you choose the securities that meet your criteria for risk.
What does a beta of utility mean?
Many utility sector stocks have a beta of less than 1. Essentially, beta expresses the trade-off between minimizing risk and maximizing return. Say a company has a beta of 2. This means it is two times as volatile as the overall market. We expect the market overall to go up by 10%.
What is the beta of a young technology company?
Many young technology companies that trade on the Nasdaq stocks have a beta greater than 1. Many utility sector stocks have a beta of less than 1.
What does beta mean in Bloomberg?
When you look up a company’s beta on Bloomberg, the default number you see is levered, and it reflects the debt of that company. Since each company’s capital structure is different, an analyst will often want to look at how “risky” the assets of a company are regardless of the percentage of its debt or equity funding.
What are Equity Beta and Asset Beta?
Levered beta, also known as equity beta or stock beta, is the volatility of returns for a stock, taking into account the impact of the company’s leverage from its capital structure. It compares the volatility (risk) of a levered company to the risk of the market.
What is leverage beta?
Levered beta (equity beta) is a measurement that compares the volatility of returns of a company’s stock against those of the broader market. In other words, it is a measure of risk and it includes the impact of a company’s capital structure and leverage. Equity beta allows investors to assess how sensitive a security might be to macro-market risks. For example, a company with a β of 1.5 denotes returns that are 150% as volatile as the market it is being compared to.
How to find levered beta?
There are two ways to estimate the levered beta of a stock. The first, and simplest, way is to use the company’s historical β or just select the company’s beta from Bloomberg. The second, and more popular, way is to make a new estimate for β using public company comparables. To use the comparables approach, the β of comparable companies is taken from Bloomberg and the unlevered beta for each company is calculated.
Why is equity beta called equity beta?
It is also commonly referred to as “equity beta” because it is the volatility of an equity based on its capital structure. Capital Structure Capital structure refers to the amount of debt and/or equity employed by a firm to fund its operations and finance its assets. A firm's capital structure.
What is asset beta?
Unlevered Beta / Asset Beta Unlevered Beta (Asset Beta) is the volatility of returns for a business, without considering its financial leverage. It only takes into account its assets. , on the other hand, only shows the risk of an unlevered company relative to the market.
How to calculate the weekly return of a stock?
Follow these steps to calculate β in Excel: 1 Obtain the weekly prices of the stock 2 Obtain the weekly prices of the market index (i.e. S&P 500 Index) 3 Calculate the weekly returns of the stock 4 Calculate the weekly returns of the market index 5 Use the Slope function and select the weekly returns of the market and the stock, each as their own series 6 Congrats! The output from the Slope function is the β
Which structure minimizes the cost of equity?
c. The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price.
What is optimal capital structure?
b. The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's stock price.
Why does the Federal Reserve tighten interest rates?
d. The Federal Reserve tightens interest rates in an effort to fight inflation.
Does leverage affect equity?
Since a firm's beta coefficient is not affected by its use of financial leverage, leverage does not affect the cost of equity. d. Increasing a company's debt ratio will typically increase the marginal costs of both debt and equity financing. However, this action still may lower the company's WACC.
Does debt affect EBIT?
The amount of debt in its capital structure can under no circumstances affect a company's EBIT and business risk. b. The factors that affect a firm's business risk include industry characteristics and economic conditions, both of which are generally beyond the firm's control.
Do you have to adjust the discount rate for the project based on the firm's risk?
you must adjust the discount rate for the project based on the firm's risk.
Do you have to have actual data to determine differences in calculations?
one must have the actual data to determine any differences in the calculations .
Is beta the same as risk?
using the firm's beta is the same measure of risk as the project.
Is firm beta the same as project risk?
Both using the firm's beta is the same measure of risk as the project; and the financial risk is equal to business risk.
Why are asset play firms not competitive?
not asset play firm because the value of their firm doesn't reflect their stock. not cyclical firm because their stock prices depend on economic fluctuation.
What is contraction in economics?
contraction: inflationary period ends and demand eases, invest in pharmaceuticals or other unaffected markets. trough: the low of the economy when the market is ready to recover from recession; investors can invest in capital goods industries because firms are investing in equipment, etc. getting ready to expand.
Examples of Beta
Calculation
- Below is an Excel β calculator that you can download and use to calculate β on your own. β can easily be calculated in Excel using the Slope function. Follow these steps to calculate β in Excel: 1. Obtain the weekly prices of the stock 2. Obtain the weekly prices of the market index (i.e., S&P 500 Index) 3. Calculate the weekly returns of the stock 4. Calculate the weekly returns of the market i…
What Are Equity Beta and Asset Beta?
- Levered beta, also known as equity beta or stock beta, is the volatility of returns for a stock, taking into account the impact of the company’s leverage from its capital structure. It compares the volatility (risk) of a levered company to the risk of the market. Levered beta includes both business risk and the risk that comes from taking on debt. It is also commonly referred to as “eq…
Levered Beta vs Unlevered Beta
- Levered beta (equity beta) is a measurement that compares the volatility of returns of a company’s stock against those of the broader market. In other words, it is a measure of risk, and it includes the impact of a company’s capital structure and leverage. Equity beta allows investors to assess how sensitive a security might be to macro-market risks. For example, a company with a …
Calculation of Levered Beta
- There are two ways to estimate the levered beta of a stock. The first, and simplest, way is to use the company’s historical β or just select the company’s beta from Bloomberg. The second, and more popular, way is to make a new estimate for β using public company comparables. To use the comparables approach, the β of comparable companies is taken from Bloomberg and the un…
Interpreting Beta
- A security’s β should only be used when its high R-squared value is higher than the benchmark. The R-squared value measures the percentage of variation in the share price of a security that can be explained by movements in the benchmark index. For example, a gold ETF will show a low β and R-squared in relation to a benchmark equity index, as gold is negatively correlated with equit…
Related Readings
- Thank you for reading CFI’s guide to beta (β) of an investment security. To continue learning and advancing your career these additional resources will be helpful: 1. Types of Valuation Multiples 2. Analysis of Financial Statements 3. Leverage Ratios 4. Valuation Methods