The formula to calculate the Beta (B) is:
\[ B = \frac{C}{V} \]
Where:
A portfolio beta is defined as the ratio of the covariance to the variance of an individual stock or portfolio compared to the overall market. The higher the beta, the higher the possible return but also the higher the risk.
Covariance in the case of a portfolio beta is defined as the measure of the stock return relative to the stock market. For example, if the stock returns 10% and the market returns 8% during the same time period, the covariance would be 2%.
Variance in terms of portfolio beta is a measure of the return of the market compared to its mean. For example, if the market returns 8% for the period, but the average return is 6% for that time frame, then the variance would be 2%.
Beta should be used when analyzing short-term risks of stocks and portfolios. This is because it’s a metric for understanding relative possible short-term returns and volatility. When considering longer-term investments, big picture fundamentals are more important.
Let's assume the following values:
Using the formula to calculate the Beta:
\[ B = \frac{0.04}{0.02} = 2 \]
The Beta is 2, indicating higher risk and potential return compared to the market.
