BY- Devendra Kumar Dubey
AGENDA
INTRODUCTION
INTERPRETING BETA
APPLICATION OF BETA
ADVANTAGES LIMITATIONS
Introduction volatility Beta measures a stock's
The degree to which its price fluctuates in relation to the
overall market. Gives a sense of the stock's market risk compared to the wider market.
Beta is used also to compare a stock's market risk to that
of other stocks. Investment analysts use the Greek letter '' to represent beta.
TYPES OF BETA NEGATIVE BETA
BETA OF ZERO
BETA BETWEEN ZERO AND ONE
BETA EQUAL TO ONE BETA GREATER THAN ONE
BETA GREATER THAN 100
Types of Stock
AGGRESSIVE STOCK Beta of more than 1 indicates an aggressive stock and the value of fund is likely to rise or fall more than the benchmark. beta > 1, more risky than the market. DEFENSIVE STOCK Beta of less than 1 indicates that the stock will react less than the market index. beta < 1, indicates less risky than the market. NEUTRAL STOCK If the beta of a stock is 1 it is called neutral stock. Beta = 1, same risk as the market. This is also called average stock
NAME
BETA
of Nifty scrips NAME
PHARMACEUTICALS
BETA
AUTOMOBILES Bajaj Auto 0.40 0.80 1.23
Cipla ltd
Ranbaxy lab Dr Reddys Glaxo Pharma IT SECTOR Infosys technology Wipro ltd
0.45
0.52 0.57 0.22 TELECOM 1.51 1.77 Hero Honda M&M
MTNL
VSNL BANKING HDFC BANK
0.66
0.68
HCL Tech
Satyam FMCG Britannia Colgate-Palmolive Dabur HLL ITC
1.61
1.91
0.47 0.75 1.26 0.91
0.19 0.28 0.70 0.92 0.56 ICICI OBC SBI
Beta of aassets (stocks) in the portfolio the individual Portfolio
Beta of a portfolio can be calculated in terms of the betas of If a portfolio contains n assets with the weights w1,
w2,wn. n The rate of return of the portfolio is r = wi r i i=1 Implying = wi i P The portfolio beta is just the weighted average of the betas of the individual assets in the portfolio
The weights being identical to those that define the portfolio
Value of stock Rs 20 Rs 30 Rs 50 Beta 1.5 0.7 0.9 Weight =20 / 100 = 0.2 =30 / 100 = 0.3 =50 / 100 = 0.5
Stock A Stock B Stock C
Portfolio Value = Rs 100 Portfolio Beta = 0.2*1.5 + 0.3*0.7 + 0.5*0.9 = 0.96
Systematic Risk
Risk factors that affect a large number of assets Also known as non-diversifiable risk or market risk Includes such things as changes in GDP, inflation,
interest rates, war catastrophe etc Beta & Systematic Risk
A beta of 1 implies the asset has the same systematic risk
as the overall market A beta < 1 implies the asset has less systematic risk than the overall market A beta > 1 implies the asset has more systematic risk than the overall market
Nonsystematic Risk
Risk factors that affect a limited number of assets
Also known as unique risk and asset-specific risk Includes such things as labor strikes, part shortages,
etc.
Diversification
Principle of Diversification
Diversification can substantially reduce the variability of
returns without an equivalent reduction in expected returns This reduction in risk arises because worse than expected returns from one asset are offset by better than expected returns from another Diversification is not just holding a lot of assets For example, if you own 50 internet stocks, you are not diversified However, if you own 50 stocks that span 20 different industries, then you are diversified There is a minimum level of risk that cannot be diversified away and that is the systematic risk
Benefits of Diversification
Stability of income
Capital growth Security of principal amount invested Liquidity
Diversifying Beta Effects
Easy to track Beta effects in a portfolio
Mixing high-Beta assets with low-Beta assets gives
good portfolio effects
Rationale for mixing bonds or bond funds (which tend
to be zero Beta) with market index funds, which tend to have Beta close to 100% An asset which moves with the market (high Beta) will tend to diversify well with an asset that does not move with the market (zero Beta)
CAPM
Developed by Sharpe, Lintner and Mossin Follows logically from Markowitz mean-variance portfolio
theory ( beyond the scope of present discussion)
The problem of constructing efficient portfolio To maximize return for a specified risk
R=Rf + (Rm-Rf ) rf<rm (Rm Rf) = Market Risk Premium Current rate 6-6.5% of Risk Premium (R Rf) = (Rm-Rf) = Stock / Asset / Portfolio Risk
Premium R = expected rate of return on stock/asset/portfolio = Beta of a stock / portfolio / asset
CAPM states, based on an equilibrium argument, that the solution to the Markowitz problem is that the market portfolio is the fund (and only fund) of risky assets that anyone needs to hold Investment Science, David G Luenberger
Rf = Risk CAPMonFree Rate bonds Yield government
The yield on government depends on the maturity. E.g
10 year yield would be higher than 1 year yield. Typically taken as 8-10 year yield 8% (approx)is the current rate
Rm = Expected market rate of return Market rate is taken as return on index. E.g. Nifty (NSE) or Sensex (BSE) 14-14.5% is present market rate of return
E.g.: Rf =8% E.g.: Rf =8% Calculating CAPM.Rm=14.5%
Rm=14.5% B=0.5
B=1.5
R=8+1.5(14.5-8) R=17.75%
R=8+0.5(14.5-8) R=11.25%
ADVANTAGES RISK. ACTS AS A PROXY FOR
IT IS A CLEAR QUANTIFIABLE MEASURE.
SHARES BOUNCED MORE THAN THE MARKET.
LIMITATIONS
BETA IS NOT FUTURISTIC
BETA DOES NOT TAKE INTO ACCOUNT ALL THE
FACTORS AFFECTING THE STOCK PRICES
ALL STOCKS HAS A TENDENCY TO COME TO
ACHIEVE NORMAL BETA i.e.1
