Beta

or….

“What Is Beta and How Is It

Calculated?”
 Beta
 A “coefficient measuring a stock’s relative
volatility”

 Beta measures a stock’s sensitivity to

overall market movements

Source:UBS Warburg Dictionary of Finance and Investment Terms

 In practice, Beta is measured by comparing
changes in a stock price to changes in the
value of the S&P 500 index over a given
time period

 The S&P 500 index has a beta of 1

 A Generic Example
 Stock XYZ has a beta of 2

 The S&P 500 index increases in value by

10%

 The price of XYZ is expected to increase

20% over the same time period
 Beta can be Negative
 Stock XYZ has a beta of –2

 The S&P 500 index INCREASES in value

by 10%

 The price of XYZ is expected to

DECREASE 20% over the same time
period
 If the beta of XYZ is 1.5 …

 And the S&P increases in value by 10%

 The price of XYZ is expected to increase

15%
 A beta of 0 indicates that changes in the
market index cannot be used to predict
changes in the price of the stock

 The company’s stock price has no

correlation to movments in the market index
 Company Beta
AMGN 0.82
BRK.B 0.73
C 1.37
XOM 0.10
MSFT 1.80
MWD 2.19
NOK 2.05
PXLW 1.93
TXN 1.70
VIA.B 1.39
Source: taken from yahoo.finance.com, except PXLW from
 Beta and Risk
 Beta is a measure of volatility

 Volatility is associated with risk

 Risk-Reward Curve
Risk

Expected Return
 If beta is a measure of risk, then investors
who hold stocks with higher betas should
expect a higher return for taking on that risk

 What does this remind you of?

 Beta and CAPM
The capital asset pricing model:

E(R) = Rf + B(Rm-Rf)

where:
E(R) = Expected return
Rf = risk free rate of return
B = beta
Rm = market return
 WACC
Weighted average cost of capital:

WACC = (D/V)*Rd*(1-T) + (E/V)*Re

where:
D = market value of firm’s debt
Rd = return on debt securities
T = tax rate
E = market value of firm’s equity securities
Re = return on equity securities (from CAPM)
V = total value of firm’s securities (D + V)
 WACC and Beta
 WACC increases as the beta and the rate of
return on the equity securities increases (all
else constant)
 WACC is used as the discount rate in DCF
models
 Therefore, increasing WACC reduces the
firms valuation to reflect the increase in risk
 How to Calculate Beta

Beta = Covariance(stock price, market index)

Variance(market index)

**When calculating, you must compare the

percent change in the stock price to the
percent change in the market index**
 How to Calculate Beta
 Easily calculated using Excel and Yahoo!
Finance
 Use COVAR and VARP worksheet
functions
 An example:

Calculate the beta of Citigroup stock over

the 5-yr time period from Jan. 1, 1997 –
Dec. 31, 2001
S&P 500 Adjusted Daily Closing
Values: January 1, 1997 - Decem
ber 31, 1997
Citigroup
Adjusted Daily Closing Prices: J
anuary 1, 1997 - December 31, 1
997