Beta Factor Characteristics

Beta Factor Characteristics

Beta factor is used to determine or reflect the systematic risk. Beta factor are used to calculate the expected return from a market or security by using CAPM

Beta Factor for Market Portfolio

1)   Beta Represent Risk

Beta simply represents risk proportion of holding market portfolio. It means that if you don’t hold any market securities, then beta factor would be zero.

2)   Zero Beta for Risk Free

Beta factor is zero for risk free investment portfolio. If your investment portfolio comprise of all risk free investment, then there will be zero beta factor.

3)   1 Beta Factor

Beta factor would be equal to 1, if you hold an investment portfolio and does not hold any risk free security. Therefore effectively market beta factor range is from 0 to 1.

4)   Beta Factor

Beta factor changes with the proportion of market securities holding. If you hold 70% market security, then your portfolio beta is .7, when you hold 50% market securities, then your beta factor are 50%.

Beta Factor for Security

Beta Factor for security is the risk of security in relation to the market portfolio. Beta factor for security can be classified into three classes.

1.                   Higher than Market

Security systematic risk may be higher than market; it will be represented by a value more than one (1).

2.                  Lower Than Market

Systematic risk for a security may be lower than market risk, and it is represented by less than one value.

3.    Equal to Market

Systematic risk for a market may be equal to the market and it is represented by a value equal to one.

Security Beta Factor Formula

Security Beta factor may be represented mathematically as follow

     Beta Factor for security=           Systematic Risk of Security

                                                    Systematic Risk market

Security Beta Factor Calculate

1.   First Formula

Beta Factor for security=       Correlation Coefficient x S.D (Security Risk)

                                                                   S.D (Market Risk)

Example

ABC company standard deviation of security risk 4%, and standard deviation of market is 3%, coefficient of correlation is .9.

= [.9x 4%]/3%

=1.2 (Beta Factor for security)

2.   Second Formula

Beta Factor for Security =                       Covariance (s,m)           .

                                                                             Variance (market Risk)