Beta (β): Measuring Systematic Risk 📉🏛️
While Standard Deviation measures the Total Risk of a stock, Beta (β) measures its Relative Risk compared to the overall market. It tells us how much a stock's price is likely to move when the market moves.
Important
Beta only measures Systematic Risk. It does not tell you about the company's internal problems (like a strike or management change).
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Key Difference
While Standard Deviation measures total risk, Beta measures ONLY Systematic Risk (Market Risk).
2. Calculation of Beta
Beta is calculated by comparing the covariance of the stock with the market to the variance of the market.
Formula:
Beta (β) = Cov(Ri, Rm) / Var(Rm)
Where:
- Beta i = Beta of stock i.
- Cov(Ri, Rm) = Covariance between the returns of the stock and the market.
- Var(Rm) = Variance of the market returns.
3. Interpretation of Beta Values
Investors use Beta to build portfolios that match their risk tolerance.
| Beta Value | Classification | Meaning |
|---|---|---|
| 0.0 | Risk-Free | No correlation with the market (e.g., Cash/Gold). |
| 0.1 to 0.9 | Defensive | Moves less than the market (e.g., Utility or FMCG stocks). |
| 1.0 | Market | Moves exactly with the market index. |
| 1.1 to 2.0 | Aggressive | Moves more than the market (e.g., Tech or High-growth stocks). |
| Negative Beta | Anti-Market | Moves in the opposite direction of the market (Very rare). |
4. Why is Beta Important?
- Risk Management: If you expect a market crash, you should hold Low-Beta stocks to protect your capital.
- CAPM: Beta is the most important variable in the Capital Asset Pricing Model (which we will learn in Unit IV) to determine the "fair" return of a stock.
- Benchmarking: It helps in understanding if a fund manager's high returns are due to skill or simply because they took high market risk.
Summary
- Beta (β) measures sensitivity to Market (Systematic) Risk.
- The Market itself always has a Beta of 1.0.
- High Beta = High sensitivity (Aggressive).
- Low Beta = Low sensitivity (Defensive).
- Standard Deviation measures Total Risk; Beta measures Market Risk.
Quiz Time! 🎯
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