BETA COEFFICIENT

• Is a measurement of its volatility of returns relative to the entire

market.
• It measure how likely the price of a security or a stock will change to
a movement in the market price.
• It is the index of risk that quantifies the responsiveness of a stocks
return to changes in the return on the market.
• Beta coefficients have become more widely
used by financial analyst to measure the risk
associated with the INDIVIDUAL STOCKS.
• There is also PORTFOLIO BETA, the
weighted average of the individual betas in
the portfolio.
• A BETA COEFFICIENT OF 1 means the stock return moves exactly with
an index of the market as a whole.
• FOR EXAMPLE:

A 10 percent increase in the market produces a 10 percent increase

in the return on the specific stock. Correspondingly, a 10 percent
decline in the market results in a 10 percent decline in the return of the
stock.
• A BETA COEFFICIENT OF LESS THAN 1 implies that the return on the
stock tends to fluctuate less than the market as whole. Underperform
the market during periods of rising stock prices but outperform the
market as a whole during the periods of declining prices.
For EXAMPLE:
A Coefficient of 0.7 indicates that the stocks return will rise only 7
percent as a result of a 10 percent increase in the market but will fall
only by 7 percent when the market declines by 10 percent.
• BETA COEFFICIENT OF MORE THAN 1 suggest that stock is more
stable than the whole stock market. They conclude higher return
during rising in the market but they also indicate greater losses
during declining the markets.

• For example:
• A beta coefficient of 1.2 means that the return on the stock will rise
by 12 percent if the market increases by 10 percent but the return on
the stock will decline by 12 percent when the market declines by 10
percent.
• The Greater the BETA COEFFICIENT, the more market risk is
associated with the individual stock.

• High Beta Coefficient may indicate higher returns during rising

markets, but they also indicate greater losses during declining
markets. Stocks with Higher BETA is called “AGGRESSIVE”.

• LOW BETA COEFFICIENTS underperformed the market during periods

of rising stock prices but outperform the market as a whole during
periods of declining prices. Stocks are referred to as “DEFENSIVE”.
• The Horizontal axis represents the Percent return on the market index,
and the Vertical axis represents the Percentage return on the individual
stock. The line AB, which represents the market, is the same in both
graphs.
• Part (a) of figure 8.5 illustrates stock with a beta coefficient greater than
1. line CD represents stock whose return rises and declines more than
the market return. In this case the beta coefficient is 1.2, so when the
market index is 10 percent, this stocks return is 12 percent.
• Part (b) illustrates a stock with a beta coefficient of less than 1. Line EF
represents a stock whose return rises and declines more slowly than
that of the market. In this case, the beta coefficient is 0.8, so when the
market’s return is 10 percent this stock’s return is 8 percent.
 COMPANY BETA COEFFICIENT
EXXONMOBIL 0.37

VERIZON COMMUNICATONS 0.57

HEINZ 0.63

IBM 0.68

GE 1.68

ALCOA 2.11

HARLEY DAVIDSON 2.37

BANK OF AMERICA 2.58

• Some firms illustrated in above, such as Verizon Communications
have relatively low beta coefficients, while the coefficient for other
firms such as ALCOA are more higher.
• If you are willing to bear risk, you may attracted to those stocks with
higher beta coefficients, because when stock market prices rise,
these stocks tend to outperformed the market. If you are less
inclined to bear risk, you may prefer the stocks with low beta
coefficients, you may forgo some potential return during rising
market prices but should suffer smaller losses during declining
markets.
• The average beta coefficient of the portfolio
illustrated in exhibit 8.1 is approximately
1.37. If an equal dollar amount is invested
in each security, the value of the portfolio
should be more volatile than the market,
even though individual beta coefficients are
less than 1.
• BETA COEFFICIENTS must be reliable predictors of future stock price
behavior.
For example:
If you desire stocks that will be stable, you will probably purchase
stocks with low beta coefficients. An investor selecting a stock with a
beta coefficient of 0.6 will certainly be upset if the market prices
decline by 10 percent and this stock’s will fall to 15 percent, since a
coefficient of 0.6 indicates that the stock price should decline by only
6 percent when market prices decline by 10 percent.
• Unlike the beta coefficients of Individual Securities, the beta
coefficient of portfolio composed of several securities is fairly stable
over time. A portfolio beta coefficient can be used as a tool to
forecast its future beta coefficient, and this projection should be more
accurate than forecasts of an individual securities beta coefficient.

• Since a portfolios of beta coefficient is stable, the investor can

construct a portfolio that responds in a desired way to market
changes. For example:
CALCULATING BETA USING A SIMPLE EQUATION
• 1ST STEP: FIND THE RISK FREE RATE
• 2ND STEP: DETERMINE THE RESPECTIVE RATES OF RETURN FOR THE
STOCK AND THE MARKET RETURN
• 3rd STEP: SUBTRACT THE RISK FREE RATE FROM THE STOCK’S RATE OF
RETURN
• 4th STEP: SUBTRACT THE RISK FREE RATE FROM THE MARKET RATE OF
RETURN
• 5TH STEP: DIVIDE THE DIFFERENCE ABOVE BY THE SECOND DIFFERENCE
ABOVE
• B<1 – the stock is less volatile than the market as a whole
• B>1 – the stock is more volatile than the market as a whole
• B<0 – the stock is losing money while the market as a whole is gaining
Using Beta to Determine a Stock’s Rate of Return
• 1ST STEP: FIND THE RISK FREE RATE
• 2ND STEP: DETERMINE THE RATE RETURN FOR THE
MARKET
• 3RD STEP: MULTIPLY THE BETA VALUE BY THE
DIFFERENCE BETWEEN THE MARKET RATE OF
RETURN AND RISK FREE RATE
• 4TH STEP: ADD THE RESULT TO THE RISK FREE RATE
MAKING SENSE OF THE BETA
• 1ST : KNOW HOW TO INTERPRET BETA
• 2ND: KNOW THAT RISK IS USUALLY RELATED TO RETURN
• 3RD: EXPECT THAT A STOCK WITH A BETA OF ONE WILL MOVE IN
LOCKSTEP WITH THE MARKET
• 4TH: PUT BOTH HIGH AND LOW BETA STOCKS IN YOUR PORTFOLIO
FOR ADDEQUATE DIVERSIFICATION.
• 5TH: UNDERSTAND THAT LIKE MOST FINANCIAL PREDICTION TOOLS,
BETA CANNOT REALIBY PREDICT THE FUTURE
 BETA PORTFOLIO
• Although we know the individual betas because
HOW DO WE
they re usually given
CALCULATE BETA OF THE
PORTFOLIO?
Bp = Portfolio Beta
Ws = Weighted Stock
Bs = Security Beta
N = Number of Securities
FORMULA:
Bp = Bs1 Ws1 + Bs2 Ws2 + Bsn Wsn
• Suppose you have a portfolio that consists of 4
stocks: 25% in a stock with a beta of 1.2, 25% in a
stock with a beta of .80, 40% in a stock with a beta of
1.45, and 10% in a stock with a beta of 1.9. What is
the beta portfolio?

Bp = 1.2(.25)+.80(.25)+1.45(.40)+1.9(.10) = 1.27
 BETA OF PORTFOLIO
B WEIGHTS B(WEIGHT)
S1 1.2 0.25 O.3
S2 0.8 0.25 O.2
S3 1.45 O.4 0.58
S4 1.9 0.1 0.19
PORTFOLIO BETA = 1.27
• Now suppose you have a portfolio with a beta of 1.12 that
consists of 10 different stocks. You have $5000 invested in each
stock making the total value of your portfolio $50,000. Now
suppose you sold $5000 of one stock that had a beta of 1 and
replaced it with $5000 worth of stock with a beta of 1.5. What
would the new beta be for your portfolio after the change?

• Since you are selling $5000 of a stock and your total portfolio is
worth $50,000, you are selling 10% of your portfolio
(5000/50000=.10). If you are selling 10% of your portfolio then you
have the rest remaining which is 90%. What you need is to figure
out the beta of the 10% and you know the total portfolio’s beta,
you can solve algebraically.
• First find the beta of the remaining 90% that is not being
sold.
x(.90) + 1(.10) = 1.12
x(.90) + .10 = 1.12
x(.90)=1.12- .10
x(.90) = 1.02

B of remaining 90% = x = 1.02 = 1.1333

.90
• Now you have the beta of the of the remaining
90% of your portfolio which is 1.1333, and you
know that you are replacing the other hand
10% with a stock that has a beta of 1.5. You
would simply plug these numbers into the beta
of a portfolio equation to solve for the
portfolios beta after the change.
B of new portfolio = 1.1333(.900) + 1.5(.10) =
1.17
 REGRESSION ANALYSIS AND THE
ESTIMATION OF BETA COEFFICIENTS
• REGRESSION ANALYSIS is used to estimates stock’s
beta coefficient.
• These data plotted in figure 8.6 with each point
representing one set of observations. For example,
point A represent as 4 percent increase in the return
on the stock in response to 5 percent increase in the
market. Point B represents 7 percent decrease in the
return on the stock in response to a 5 percent decline
in the return on the market.
The individual observations are summarized by linear regression
analysis, which is used to compute an equation relating the return of
the stock (Rs dependent variable) to the return on the market (Rm ,
the independent variable). The regression analysis computes the y-
intercept (a) and the slope (b) for the following equation.

Rs = A+ Bm
A manual computation of the process is presented in exhibit 8.2 in
which the ff. equation is derived.
Rs = 0.000597 + 0.9856r
COMPUTATION OF A BETA COEFFICIENT
• This regression equation can be used to forecast the
expected return on the stock. If the individual anticipates
that the market will be 20 percent, the stock should yield a
return of
• Rs = -0.000598 + 0.9856(20%) = 19.7%
• As with any forecast, this result may not be realized,
because factors other than increase in the market may
affect the stocks return. (these factors are
• The unsystematic risk associated with the stock. The
predictive power of this particular beta may be excellent,
because the individual observations lie close to the
estimated regression line. That indicates a high correlation
between two variables. The actual correlation coefficient is
0.976 which indicates a strong, positive relationship
between the return of stock and the return on the market.
A correlation of 1.0 indicates a perfect positive relationship.