Beta Calculation for Stocks

Beta Formula:

\[ \beta = \frac{Cov(r_s, r_m)}{Var(r_m)} \]

Stock Beta:

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1. What is Stock Beta?

Beta (β) measures a stock's volatility relative to the overall market. It indicates how much the stock's price tends to move compared to the market as a whole. A beta of 1 means the stock moves with the market, while a beta greater than 1 indicates higher volatility than the market.

2. How Does the Calculator Work?

The calculator uses the beta formula:

\[ \beta = \frac{Covariance(Stock, Market)}{Variance(Market)} \]

Where:

\( Covariance(Stock, Market) \) — Measures how stock returns move with market returns
\( Variance(Market) \) — Measures the dispersion of market returns

Explanation: Beta is calculated by dividing the covariance of the stock's returns with the market's returns by the variance of the market's returns.

3. Importance of Beta Calculation

Details: Beta is a key component in the Capital Asset Pricing Model (CAPM) and helps investors understand a stock's risk profile. It's used to estimate expected returns and to construct diversified portfolios.

4. Using the Calculator

Tips: Enter the covariance between the stock and market returns, and the variance of the market returns. Both values should be calculated from the same time period and frequency (e.g., daily, weekly, or monthly returns).

5. Frequently Asked Questions (FAQ)

Q1: What does a beta of 1.5 mean?
A: A beta of 1.5 means the stock is 50% more volatile than the market. If the market rises 10%, the stock tends to rise 15%; if the market falls 10%, it tends to fall 15%.

Q2: Can beta be negative?
A: Yes, negative beta means the stock moves inversely to the market. These are rare but can occur with certain inverse ETFs or gold stocks.

Q3: What time period should be used to calculate beta?
A: Typically 3-5 years of monthly data or 1-2 years of weekly data. Shorter periods may not capture full market cycles.

Q4: How does beta relate to diversification?
A: Combining stocks with different betas can help create a portfolio with your desired level of market risk.

Q5: What are limitations of beta?
A: Beta assumes past price relationships will continue, doesn't account for new information, and may not reflect fundamental changes in a company.