Beta in Finance and the Stock Market Explained (A Clear and Complete Guide)

https://joemaule.com

In finance, the greek letter Beta is a measure of how the price of a stock or security tends to move compared to the rest of the market.

In the stock market, beta is a measure of a stock's volatility in relation to the overall market. It is calculated using a regression analysis of the stock's returns against the returns of the market as a whole, typically over a period of several years. A beta of 1 indicates that a stock's price will move in line with the market, while a beta less than 1 means it is less volatile than the market, and a beta greater than 1 indicates higher volatility. Beta is used by investors to evaluate the potential risk of a stock and to help determine an appropriate allocation for it in their portfolios.

Beta represents a stock's exposure to systematic risk, or non-diversifiable risk. It tries to estimate how an investment's price will react to changes in broad economic conditions that affect all companies.

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. To calculate beta, you will need the following information:

The returns of the security or portfolio that you are interested in.
The returns of the market as a whole.
Once you have this information, you can use the following formula to calculate beta:

Beta = (Covariance of the security or portfolio with the market) / (Variance of the market)

Where covariance is a measure of the joint variability of two variables, and variance is a measure of the variability of a single variable.

To calculate beta, you will first need to calculate the covariance of the security or portfolio with the market. This can be done using the following formula:

Covariance = (1 / (n - 1)) * ∑(Ri - R̅)(Mi - M̅)

Where:

Ri is the return of the security or portfolio in a given period.
R̅ is the average return of the security or portfolio over the entire time period.
Mi is the return of the market in a given period.
M̅ is the average return of the market over the entire time period.
n is the number of periods in the time series.
Once you have calculated the covariance of the security or portfolio with the market, you can then calculate the variance of the market using the following formula:

Variance = (1 / (n - 1)) * ∑(Mi - M̅)^2

Once you have calculated the variance of the market, you can then divide the covariance of the security or portfolio by the variance of the market to obtain its beta.

The Capital Asset Pricing Model (CAPM) is a model used in finance to determine the expected return of an asset. The model takes into account the risk of the asset, as measured by its beta, and the expected return of the market as a whole.

The formula for the expected return of an asset using the CAPM is as follows:

Expected return = Risk-free rate + (Beta x (Expected market return - Risk-free rate))

Where:

Risk-free rate is the return on an investment with no risk, such as a government bond.
Beta is a measure of the volatility, or systematic risk, of an asset in comparison to the market as a whole.
Expected market return is the expected return of the market as a whole.
To use the CAPM, you will need to know the risk-free rate, the beta of the asset you are interested in, and the expected return of the market. Once you have this information, you can plug it into the formula to determine the expected return of the asset.

For example, suppose the risk-free rate is 2%, the beta of an asset is 1.5, and the expected return of the market is 8%. Using the CAPM formula, the expected return of the asset would be 2% + (1.5 x (8% - 2%)) = 11%. This means that, according to the CAPM, an investor can expect to earn an 11% return on the asset.

Song: Walking in the Sky by Nico Staf

TIMESTAMPS -
0:00 Intro
0:17 Beta = 1: Correlation and Volatility
0:51 Beta = 1 Visa Chart Example
1:28 Company Specific Risk
1:45 Beta as Systematic Risk Example
2:27 Company Specific Risk, Diversifiable Risk Example
3:13 Systematic Risk 2nd Example
3:32 Beta Greater than 1 NVIDIA Example
4:50 Beta Less than 1 Wal-Mart Example
6:01 Negative Beta Example: Gold
6:22 Beta = 0, No Correlation, Cash
6:44 Why is Beta Important?
7:37 Downsides to Using Beta
8:12 Calculating Beta
9:35 Using Beta to Predict Stock Returns

#finance
#investing
#stocks

Disclaimer: I am not a financial advisor, this not investment advice, this is for educational purposes only