Beta of Stock

Beta of a stock is relation depicting the return the stock yield with respect to the yield in the financial market. It can also be termed as the relationship of the stock fluctuation with respect to the market fluctuation. For ex a stock with zero beta will not change with respect to market change. In case of stock with a beta one will have a high correlation with the market. In case of positive beta stock the stock goes in positive direction if the market goes in positive direction whereas it goes in negative direction if the market goes in negative direction. If the market changes the stock changes along with the market to the same extend as that of the market.  In case if the stock has a beta value of -1 i.e. negative beta stock varies in the opposite direction to that of the market i.e. if the market goes positive the stock will go negative whereas if the market goes negative the stock will go positive. The negative beta stock

Beta of stock is given by the formula,

β of stock=Variance (r_a )/variance (r_m)

Where r_a is the variance of the stock, r_m is the variance of the market performance.

Advantages of calculating Beta are,

• In case of CAPM method beta estimation plays a vital role.
• The price fluctuation of a stock can be predicted to some extend if the beta value of the stock and the market movement is known.
• Risk aversion is possible to a greater extend if beta value is used properly.
• Beta is a term which can be understood by the investor easily.

Disadvantage of beta way of estimating the price of the stocks are,

• Beta estimation does not give any other information about the stock other than its relation with the market. The starter might find it difficult to understand the stock performance by using only beta values.
• Beta cannot predict the future price. It can be useful only if the movement of the market is known.
• Beta estimation can be used by traders. Investors cannot make investment decision based on this value.  It is highly meant for short term investment.  

Questions

• What are the advantages of using beta of a stock?
• What is various form of beta for stocks?