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Paathshaala : Beta of Portfolio

Beta of Portfolio(Beta)

Betas are widely used to measure the volatility of a stock fund's price relative to the general market. The beta relates the volatility of a single security to the volatility of the market as a whole.

This common measure compares a mutual fund's volatility with that of a benchmark and is supposed to give some sense of how far you can expect a fund to fall when the market takes a dive, or how high it might climb if the bull is running hard. A fund with a beta greater than 1 is considered more volatile than the market; less than 1 means less volatile.

An issue with a beta of 1.5 for example, tends to move 50% more than the total market, in the same direction. An issue with a beta of 0.5 tends to move 50% less. If a stock or stock fund moved exactly as the market moved, it would have a beta of 1.0. Thus, high beta is typical of a volatile stock. Low beta is typical of a stock that moves less than the market as a whole. A stock with a negative beta moves in the direction opposite to that of the market. With a beta of -1.0 a stock has the same volatility as the market, but tends to rise when the market falls, and vice versa.

The beta coefficient is a key parameter in the capital asset pricing model (CAPM). It measures the part of the asset's statistical variance that cannot be mitigated by the diversification provided by the portfolio of many risky assets, because it is correlated with the return of the other assets that are in the portfolio.

This correlated risk, measured by Beta, is what actually creates almost all of the risk in a diversified portfolio.

The formula for the Beta of an asset is

where ra measures the rate of return of the asset and rp measures the rate of return of the portfolio of which the asset is a part. In the CAPM formulation, the portfolio is the market portfolio that contains all risky assets, and so the rp terms in the formula are replaced by rm, the rate of return of the market.

Beta is also referred to as financial elasticity or correlated relative volatility, and can be referred to as a measure of the asset's sensitivity of the asset's returns to market returns, its non-diversifiable risk, its systematic risk or market risk. On a portfolio level, measuring beta is thought to separate a manager's skill from his or her willingness to take risk.

The beta movement should be distinguished from the actual returns of the stocks. For example, a sector may be performing well and may have good prospects, but the fact that its movement does not correlate well with the broader market index may decrease its beta. However, it should not be taken as a reflection on the overall attractiveness or the loss of it for the sector, or stock as the case may be. Beta is a measure of risk and not to be confused with the attractiveness of the investment.

Important to note: Beta, though a useful guide, is far from perfect, especially when used as a proxy for "risk." The problem here, as with many risk measures, is the benchmark. The benchmark has to be a correct measure of comparison only then will the beta hold any indicative value.

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