Common Financial Terms & Concepts

What is Beta (β) in Finance? Stocks

Beta (β) is a Greek letter, the second letter of Greek alphabet, and its numeric value is 2.

Beta (β): Definition

Beta (β), in finance, measures volatility i.e. a measure of systematic risk for a particular security, or a portfolio as a whole. Beta (β), in a very limited sense, also explains correlation between price movement of a particular security and the market as a whole ( market as a whole simple means benchmark indexes, like NSE)

Beta (β) = Covariance of Individual Return of Stock/Portfolio and Market Return / Variance of Market Return

Beta (β): Meaning and Examples

The aforementioned formula of Beta (β) can have three possible outcomes. Either it can be 0, between 0 and 1, or more than 1. Note that it can be negative too, so it can also be between -1 and 0, and less than -1.

A positive Beta (β) represents direct relation between stock and index, meaning for every increase in the index, the stock/portfolio would also increase. If Beta (β) is less than one, it means that the increase in security would be not as much as the index. For instance, a stock with Beta (β) = 0.5, if the market increases by 15 points, the stock would increase by 7.5 points. (If the market falls by 15 bps, the stock would also fall by 7.5 bps)

A Beta (β) that is greater than one means that the security outperforms the index. A stock with Beta (β) = 1.5, in a market that rises by, say 20 bps, would rise by 30 bps.

A negative beta, on the other hand, shows inverse relationship between the stock and the market. For example, if the Beta (β) = -0.5, and the market falls by 15 bps, the stock would rise by 7.5 bps.

Similarly, if Beta (β) = -1.5, and the market rises by 20 bps, the stock would fall by 30 bps.

Beta (β) is used in Capital Asset Pricing Model (CAPM) and defines systematic risk. Systematic risk is basically the kind of risk that can only be accounted for from a statistical perspective, meaning it is a non-diversifiable risk.

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