Financial Terms Beta

# Definition of Beta

## Beta

A measure of the riskiness of a specific security compared to the
riskiness of the market as a whole; measure of the systematic risk
of a security or a portfolio of securities

## Beta

The price volatility of a financial instrument relative to the price
volatility of a market or index as a whole. beta is most commonly used with
respect to equities. A high-beta instrument is riskier than a low-beta
instrument.

portfolio.

# Related Terms:

## Beta (Mutual Funds)

The measure of a fund's or stocks risk in relation to the market. A beta of 0.7 means
the fund's total return is likely to move up or down 70% of the market change; 1.3 means total return is likely
to move up or down 30% more than the market. beta is referred to as an index of the systematic risk due to
general market conditions that cannot be diversified away.

## Beta equation (Mutual Funds)

The beta of a fund is determined as follows:
[(n) (sum of (xy)) ]-[ (sum of x) (sum of y)]
[(n) (sum of (xx)) ]-[ (sum of x) (sum of x)]
where: n = # of observations (36 months)
x = rate of return for the S&P 500 Index
y = rate of return for the fund

## Beta equation (Stocks)

The beta of a stock is determined as follows:
[(n) (sum of (xy)) ]-[(sum of x) (sum of y)]
[(n) (sum of (xx)) ]-[(sum of x) (sum of x)]
where: n = # of observations (24-60 months)
x = rate of return for the S&P 500 Index
y = rate of return for the stock

## Country beta

Covariance of a national economy's rate of return and the rate of return the world economy
divided by the variance of the world economy.

## Expected return-beta relationship

Implication of the CAPM that security risk premiums will be
proportional to beta.

## Foreign market beta

A measure of foreign market risk that is derived from the capital asset pricing model.

## Fundamental beta

The product of a statistical model to predict the fundamental risk of a security using not
only price data but other market-related and financial data.

## Leveraged beta

The beta of a leveraged required return; that is, the beta as adjusted for the degree of
leverage in the firm's capital structure.

## Unleveraged beta

The beta of an unleveraged required return (i.e. no debt) on an investment when the
investment is financed entirely by equity.

## Zero-beta portfolio

A portfolio constructed to represent the risk-free asset, that is, having a beta of zero.

## Beta coefficient

A measurement of the extent to which the returns on a given stock move with stock market.

## Beta risk

Risk of a firm measured from the standpoint of an investor who holds a highly diversified portfolio.

## CARs (cumulative abnormal returns)

a measure used in academic finance articles to measure the excess returns an investor would have received over a particular time period if he or she were invested in a particular stock.
This is typically used in control and takeover studies, where stockholders are paid a premium for being taken over. Starting some time period before the takeover (often five days before the first announced bid, but sometimes a longer period), the researchers calculate the actual daily stock returns for the target firm and subtract out the expected market returns (usually calculated using the firmâ€™s beta and applying it to overall market movements during the time period under observation).
The excess actual return over the capital asset pricing model-determined expected return market is called an â€˜â€˜abnormal return.â€™â€™ The cumulation of the daily abnormal returns over the time period under observation is the CAR. The term CAR(-5, 0) means the CAR calculated from five days before the
announcement to the day of announcement. The CAR(-1, 0) is a control premium, although Mergerstat generally uses the stock price five days before announcement rather than one day before announcement as the denominator in its control premium calculation. However, the CAR for any period other than (-1, 0) is not mathematically equivalent to a control premium.

## Alpha

A measure of selection risk (also known as residual risk) of a mutual fund in relation to the market. A
positive alpha is the extra return awarded to the investor for taking a risk, instead of accepting the market
return. For example, an alpha of 0.4 means the fund outperformed the market-based return estimate by 0.4%.
An alpha of -0.6 means a fund's monthly return was 0.6% less than would have been predicted from the
change in the market alone. In a Jensen Index, it is factor to represent the portfolio's performance that
diverges from its beta, representing a measure of the manager's performance.

## Alpha equation

The alpha of a fund is determined as follows:
[ (sum of y) -((b)(sum of x)) ] / n
where:
n =number of observations (36 months)
b = beta of the fund
x = rate of return for the S&P 500
y = rate of return for the fund

## Characteristic line

The market model applied to a single security. The slope of the line is a security's beta.

## Contract month

The month in which futures contracts may be satisfied by making or accepting a delivery.
Also called value managers, those who assemble portfolios with relatively lower betas, lower price-book and
P/E ratios and higher dividend yields, seeing value where others do not.

## Expected return

The return expected on a risky asset based on a probability distribution for the possible rates
of return. Expected return equals some risk free rate (generally the prevailing U.S. Treasury note or bond rate)
plus a risk premium (the difference between the historic market return, based upon a well diversified index
such as the S&P500 and historic U.S. Treasury bond) multiplied by the assets beta.

## Factor portfolio

A well-diversified portfolio constructed to have a beta of 1.0 on one factor and a beta of
zero on any other factors.

## First-pass regression

A time series regression to estimate the betas of securities portfolios.

## Fundamental descriptors

In the model for calculating fundamental beta, ratios in risk indexes other than
market variability, which rely on financial data other than price data.

## Investment product line (IPML)

The line of required returns for investment projects as a function of beta
(nondiversifiable risk).

## Market model

This relationship is sometimes called the single-index model. The market model says that the
return on a security depends on the return on the market portfolio and the extent of the security's
responsiveness as measured, by beta. In addition, the return will also depend on conditions that are unique to
the firm. Graphically, the market model can be depicted as a line fitted to a plot of asset returns against
returns on the market portfolio.

## Minimum price fluctuation

Smallest increment of price movement possible in trading a given contract. Also
called point or tick. The zero-beta portfolio with the least risk.

## Risk indexes

Categories of risk used to calculate fundamental beta, including (1) market variability, (2)
earnings variability, (3) low valuation, (4) immaturity and smallness, (5) growth orientation, and (6) financial risk.

## Second pass regression

A cross-sectional regression of portfolio returns on betas. The estimated slope is the
measurement of the reward for bearing systematic risk during the period analyzed.

## Security market line

Line representing the relationship between expected return and market risk.
Security market plane A plane that shows the equilibrium between expected return and the beta coefficient
of more than one factor.
Security selection
See: security selection decision.

## Treynor Index

A measure of the excess return per unit of risk, where excess return is defined as the
difference between the portfolio's return and the risk-free rate of return over the same evaluation period and
where the unit of risk is the portfolio's beta.

## Two-factor model

Black's zero-beta version of the capital asset pricing model.

## Capital Asset Pricing Model (CAPM)

A model for estimating equilibrium rates of return and values of
assets in financial markets; uses beta as a measure of asset risk
relative to market risk

## Security Market Line

A graph illustrating the equilibrium relationship between the
expected rate of return on securities and their risk as measured by
the beta coefficient

## capital asset pricing model (CAPM)

Theory of the relationship between risk and return which states that the expected risk
premium on any security equals its beta times the market risk premium.

## security market line

Relationship between expected return and beta.

## Market Risk

The part of security's risk that cannot be eliminated by diversification. It is measured by the beta coefficient.