How to Calculate Beta Essay

How to Calculate Beta Beta refers to the volatility of a particular stock compared against the volatility of the entire stock market or, in practice, a representative index of that market, such as the Standard and Poor’s (S;amp;P) 500. Beta is an indicator of how risky a particular stock is and is used to evaluate its expected rate of return. Beta is one of the fundamentals stock analysts consider when choosing stocks for their portfolios, along with price-to-earnings ratio, shareholder’s equity, debt-to-equity ratio and other factors. Here’s how to calculate beta and use beta to figure an expected rate of return. This is the rate of return an investor could expect on an investment in which his or her money is not at risk, such as U. S. Treasury Bills for investments in U. S. dollars and German Government Bills for investments that trade in euros. This figure is normally expressed as a percentage.Determine the respective rates of return for the stock and for the market or representative index. These figures are also expressed as percentages. Usually, the rates of return are figured over several months. * Either or both of these values may be negative, meaning that investing in the stock or the market (index) as a whole would mean a loss against the investment during the period. Subtract the risk-free rate from the market (or index) rate of return. If the market or index rate of return is 8 percent and the risk-free rate is again 2 percent, the difference would be 6 percent. Divide the difference in the stock’s return rate minus the risk-free rate by the market (or index) rate of return minus the risk-free rate. This is the beta, which is typically expressed as a decimal value. In the example above, the beta would be 5 divided by 6, or 0. 833. * The beta of the market itself, or its representative index, is by definition 1. 0, as the market is being compared against itself and any nonzero number divided by itself equals. A beta less than 1 means that the stock is less volatile than the market as a whole, while a beta greater than 1 means the stock is more volatile than the market as a whole. The beta value can be less than zero, meaning either that the stock is losing money while the market as a whole is gaining (more likely) or that the stock is gaining while the market as a whole is losing money (less likely). * When figuring beta, it is common, though not required, to use an index representative of the market in which the stock trades. For U. S. stocks, the S&P 500 is the index sually used, although an industrial stock may be better served by comparing it against the Dow Jones Industrial Average.