Beta

Beta is a measure of the stock’s volatility and is used to evaluate the expected rate of return i.e. the amount of return that investors required to compensate for the risk (KSigman, 2005). Generally, representative index e.g. S&P 500 for US stocks can be used to obtain beta. With the given information, this can be applied to the above CAPM equation to obtain the stock’s beta.

E(r) = Rf + B(Rm – Rf)

8% = 2% + B (8%)

B = 0.75

The beta obtained shows that it is less volatile than the market as a whole and a beta less than 1.0 implies stocks from a utility company(Little, 2013). So during a bear market, when the market moves down by 10%, the stock price will tend to fall by 7.5%. Vice versa, during a bull market, it may not give the highest returns.

In general, a mix of high and low beta stocks aids as an adequate diversification. Like most financial prediction tools, the beta only measures the volatility of the stock in the past using historical data. Beta fluctuates all the time, thus it may not be an accurate measure to predict its current volatility.