How to Calculate Beta

The formula for calculating beta is the covariance of the return of an asset and the return of
the benchmark divided by the variance of the return of the benchmark over a certain
period.

Beta: Covariance (ri,rm )/Variance of Market

Similarly, beta could be calculated by first dividing the security's standard deviation of
returns by the benchmark's standard deviation of returns. The resulting value is multiplied
by the correlation of the security's returns and the benchmark's returns.

Beta: Correlation (ri,rm)* S.D(i)/ S.D(m)

For example, an investor wants to calculate the beta of Apple Incorporated when compared
to the SPDR S&P 500 ETF Trust. Based on hypothetical data over the past five years, assume
the correlation between Apple Incorporated and the SPDR S&P 500 ETF Trust is 0.85, Apple
Incorporated has a standard deviation of returns of 28% and the SPDR S&P 500 ETF Trust
has a standard deviation of returns of 12%.

The beta of Apple Incorporated is 1.98, or 0.85 multiplied by 0.28 divided by 0.12. In this
hypothetical case, Apple Incorporated is considered more volatile than the market
exchange-traded fund (ETF). Apple Incorporated theoretically experiences 98% more
volatility than the SPDR S&P 500 Exchange Traded Fund Trust.

For another example, assume the investor also wants to calculate the beta of Tesla Motors
Incorporated in comparison to the SPDR S&P 500 ETF Trust. In this hypothetical case, based
on data over the past five years, assume Tesla Motors Incorporated and the S&P 500 ETF
have a covariance of 0.032 and the variance of the S&P 500 ETF is 0.015. Tesla Motors
Incorporated has a beta of 2.13, or 0.032 divided by 0.015. Therefore, Tesla Motors
Incorporated is theoretically 113% more volatile than the SPDR S&P 500 ETF Trust.
Exercise

a) A share has a beta of 0.4 and an expected return of 9%. Expected return on the
market is 11%. What is the risk free rate?

b) You have found that the share of Nictus Holdings pays a return of 8%. The return of
an average asset at the NSX is 13%. The covariance of Nictus Holdings’ share with
that of the market is 18.6 while the variance of the market returns is 9.3.

Required:

1) If the three month Namibian Government Treasury Bill pays 6% currently, is the
return on the share of Nictus Holdings correct or fair?
2) Explain the justification for using the beta value when calculating returns using the
CAPM.