Beta

or.
What Is Beta and How Is It
Calculated?

Beta

A coefficient measuring a stocks relative

volatility

Beta measures a stocks sensitivity to

overall market movements

Source:UBS Warburg Dictionary of Finance and Investment Terms

In practice, Beta is measured by comparing

changes in a stock price to changes in the
value of the S&P 500 index over a given
time period

The S&P 500 index has a beta of 1

A Generic Example

Stock XYZ has a beta of 2

The S&P 500 index increases in value by

10%

The price of XYZ is expected to increase

20% over the same time period

Beta can be Negative

Stock XYZ has a beta of 2

The S&P 500 index INCREASES in value

by 10%

The price of XYZ is expected to

DECREASE 20% over the same time
period

If the beta of XYZ is 1.5

And the S&P increases in value by 10%

The price of XYZ is expected to increase

15%

A beta of 0 indicates that changes in the

market index cannot be used to predict
changes in the price of the stock

The companys stock price has no

correlation to movments in the market index

Company

Beta

AMGN
BRK.B
C
XOM
MSFT
MWD
NOK
PXLW
TXN
VIA.B

0.82
0.73
1.37
0.10
1.80
2.19
2.05
1.93
1.70
1.39

Source: taken from yahoo.finance.com, except PXLW from

Beta and Risk

Beta is a measure of volatility

Volatility is associated with risk

Risk-Reward Curve
Risk

Expected Return

If beta is a measure of risk, then investors

who hold stocks with higher betas should
expect a higher return for taking on that risk

What does this remind you of?

Beta and CAPM

The capital asset pricing model:
E(R) = Rf + B(Rm-Rf)
where:
E(R) = Expected return
Rf = risk free rate of return
B = beta
Rm = market return

WACC
Weighted average cost of capital:
WACC = (D/V)*Rd*(1-T) + (E/V)*Re
where:
D = market value of firms debt
Rd = return on debt securities
T = tax rate
E = market value of firms equity securities
Re = return on equity securities (from CAPM)
V = total value of firms securities (D + V)

WACC and Beta

WACC increases as the beta and the rate of
return on the equity securities increases (all
else constant)
WACC is used as the discount rate in DCF
models
Therefore, increasing WACC reduces the
firms valuation to reflect the increase in risk

How to Calculate Beta

Beta = Covariance(stock price, market index)
Variance(market index)
**When calculating, you must compare the
percent change in the stock price to the
percent change in the market index**

How to Calculate Beta

Easily calculated using Excel and Yahoo!
Finance
Use COVAR and VARP worksheet
functions
An example:
Calculate the beta of Citigroup stock over
the 5-yr time period from Jan. 1, 1997
Dec. 31, 2001

S&P 500 Adjusted Daily Closing

Values: January 1, 1997 December 31, 1997

Citigroup Adjusted Daily Closing

Prices: January 1, 1997 December 31, 1997