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Beta
Market risk (systematic risk) is the risk associated with the overall market and is measured using beta (). The beta of a stock simply measures the change of the stock relative to the change in the overall market. For example, if a stock has a beta of 2, it will move by 2% whenever the market moves by 1%.
Important Betas to Remember
- The market always has a beta of 1
- Risk-free assets always have a beta of 0
Wize Concept
A risk-free asset always has a beta of zero, but not all assets with a beta of zero are risk-free. An asset may have no systematic risk (beta = 0), but still have some risk (unsystematic).
Portfolio Beta
A portfolio beta is simply the weighted average of the stock beta's that make up the portfolio. For example, if a portfolio was 40% invested in Stock A with a beta of 1.2 and 60% invested in Stock B with a beta of 0.7 the portfolio beta would be 0.4(1.2) + 0.6(0.7) = 0.9
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Example: Market Risk and Beta
ABC Inc.'s stock is known to have a correlation of 0.8 with the market portfolio and a standard deviation of 10%. It is known that the market's standard deviation is 8%. What is the beta of ABC's stock?
Practice: Market Risk and Beta
The covariance between the market portfolio and Apple Inc. stock is 0.02151. The market portfolio's standard deviation is 7%, what is the beta of Apple Inc's stock?
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Example: Market Risk and Beta
You have 20% of your funds invested in the market portfolio, 50% invested in the TSLA stock with a beta of 5.5, and the rest in Canadian T-bills. What is the beta of your portfolio?
Practice: Market Risk and Beta
Your portfolio beta is 1.2 and it contains 10 different shares each with an equal amount of money invested in them. You decide to sell your shares in one of the stocks having a beta of 1.5 and invest that money into T-bills. What is your new portfolio beta? Round your answer to 4 decimal places.