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CONCEPT AND

CLASSIFICATION OF
BETA
What is Beta?

 The beta coefficient is the relative measure of


sensitivity of an asset’s return to change in
return on the market portfolio.
 It can be viewed as an index of the degree of
the responsiveness of the security’s returns
with the market return.
 The beta coefficient, β, is calculated by
relating the returns of a security with the
returns for the market.
 Mathematically, the beta of security is the
security’s covariance with the market
portfolio divided by the variance of the
market portfolio.
 When β >1 =the security is more risky.
 When β <1=the security is less risky.
 It can be calculated as:
β = COV(S,M)
∂2 m
Eg:- Following information is available in respect of a
security, S and the market portfolio M.
Probabilities Return
S M
.3 10 11
.4 16 20
.3 32 19

Find out the β of the security.


In order to find out the beta of the security,
various figures have been calculated and
summarised as follows:

S M
Avg expected 19% 17%
return
Standard .89 .0395
Deviation
Variance .00792 .00156
.00204

β= .0024 = 1.3
.00156
Classification of Beta

 PORTFOLIO BETA
 PROJECT BETA
 GEARED BETA
 UNGEARED BETA
 PROXY BETA
 FUNDAMENTAL BETA
PORTFOLIO BETA

 It is used in the context of general equities. The Beta


of a portfolio is the weighted sum of the individual
asset betas, According to the proportions of the
investments in the portfolio. E.g., if 50% of the
money is in stock A with a beta of 2.00, and 50% of
the money is in stock B with a beta of 1.00,the
portfolio beta is 1.50. Portfolio beta describes relative
volatility of an individual securities portfolio, taken as
a whole, as measured by the individual stock betas of
the securities making it up. A beta of 1.05 relative to
the S&P 500 implies that if the S&P's excess return
increases by 10% the portfolio is expected to increase
by 10.5%
 A measure of a portfolio's volatility. A beta of 1
means that the portfolio is neither more nor less
volatile or risky than the wider market. A beta of
more than 1 indicates greater volatility while a
beta of less than 1 indicates less.
 For example, if a portfolio consists of two
securities, one valued at $15,000 and having a
beta of 0.9 and the other valued at $10,000 and
having a beta of 1.5, the portfolio beta is (0.9)
( $15,000/$25,000 ) + (1.5)( $10,000/$25,000 ), or 1.14
PROJECT BETA

 Project beta basically studies the systematic


risk factor of any project . It basically
measures the risk associated with a certain
project . It is a part of capital budgeting
decisions. It is a measure of sensitivity.
 For eg a company is starting up a project . In
order to judge the sensitivity of a project a
project beta is calculated of a company.
GEARED BETA
An indication of the systematic risk attaching to
the returns on ordinary shares. It equates to the
asset Beta for an ungeared firm, or is adjusted
upwards to reflect the extra riskiness of shares in
a geared firm., i.e. th Geared Beta.
In the Capital asset pricing model (CAPM), it is
the relevant measure of total equity risk.

Also known as Geared beta . It is very well


related to the debt concept
UNGEARED BETA
 The asset beta, or corporate beta, or business beta, is a measure of
the business risk in a sector; that is the business risk alone,
unaffected by any financial risk that would be introduced by debt
financing on the balance sheet (i.e. gearing).
 Each business sector has its own unique risks and so each business
sector will have its own asset beta. It is not possible to convert an
asset beta from one sector into an asset beta for another sector;
each sector’s asset beta has to be derived from statistical analysis
(using least squares linear regression techniques).

 Since the asset beta reflects purely business risk, a company with
only equity finance on its balance sheet will find that its equity beta
is the same as the sector’s asset beta. This is because the company
has no debt finance and so does not expose its shareholders to the
financial risk associated with debt finance, hence the asset beta is
also called an ungeared equity beta.
Other classifications of Beta
Equity Beta measures the systematic business risk and
financial risk of a company.

Asset Beta measures the systematic business risk only.

Systematic risk that relates to macro economic factors


and cant be diversified.

Unsystematic risk is business related risk which can be


reduced/eliminated thought diversification.
FUNDAMENTAL BETA
The product of a statistical model to predict the
fundamental risk of the security using not only price data
but other market related and financial Data.
PROXY BETA

It is used when the firm has no market listing


and thus no Beta of its own. It is taken from a
comparable listed firm, and adjusted as
necessary for relative financial gearing levels,
Hence Proxy Discount Rate.