FINANCIAL MANAGEMENTFINANCIAL MANAGEMENTGroup Member : Group Member : Mansoor Ali Mansoor Ali

Essam Imtiaz Essam Imtiaz Taha ShahTaha Shah

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INDUS UNIVERSITYINDUS UNIVERSITY

BetaBeta

““What Is Beta and How Is It What Is Beta and How Is It Calculated?”Calculated?”

or….

BetaBeta Beta with regard to mutual fund investing, Beta with regard to mutual fund investing,

is a measure of a particular fund's is a measure of a particular fund's movement (ups and downs) compared to movement (ups and downs) compared to the overall market. For reference, the the overall market. For reference, the market is given a beta of 1.00.market is given a beta of 1.00.

A “coefficient measuring a stock’s relative A “coefficient measuring a stock’s relative volatility”volatility”

Beta measures a stock’s sensitivity to Beta measures a stock’s sensitivity to overall market movementsoverall market movements

Source:UBS Warburg Dictionary of Finance and Investment Terms

How to Calculate BetaHow to Calculate Beta

Beta = Beta = Covariance(stock price, market index)Covariance(stock price, market index)Variance(market index)Variance(market index)

**When calculating, you must compare the **When calculating, you must compare the percent change in the stock price to the percent change in the stock price to the percent change in the market index**percent change in the market index**

How to Calculate BetaHow to Calculate Beta

Simple Calculation of BetaSimple Calculation of Beta

through Capital Asset Pricing Model, we can through Capital Asset Pricing Model, we can calculate beta:calculate beta:

Required Rate of Return = Risk free rate of return Required Rate of Return = Risk free rate of return + ( Beta X Market premium rate of return )+ ( Beta X Market premium rate of return )

Beta ExampleBeta Example If risk free rate is 3% or 0.03, market If risk free rate is 3% or 0.03, market

premium rate is 6% or 0.06 and required premium rate is 6% or 0.06 and required rate of return is 14% or 0.14, then beta israte of return is 14% or 0.14, then beta is

0.14 = 0.03 + Beta X 0.060.14 = 0.03 + Beta X 0.06

0.14 - 0.03 = Beta X 0.060.14 - 0.03 = Beta X 0.06

0.11 / 0.06 = Beta0.11 / 0.06 = Beta

1.83 = Beta1.83 = Beta

Beta Co-efficientBeta Co-efficient .. Beta coefficient is a measure of sensitivity of a share price to

movement in the market price. It measures systematic risk which is the risk inherent in the whole financial system. Beta coefficient is an important input in capital asset pricing model to calculate required rate of return on a stock. It is the slope of the security market line.

Beta coefficient is given by the following formulas:

β = Covariance of Market Return with Stock Return / Variance of Market Return

There three parts of beta There three parts of beta coefficientcoefficient

  1. Beta Zero1. Beta Zero

If there is not any effect of market If there is not any effect of market return changes on any financial asset's return return changes on any financial asset's return changes, it will be beta zero. For example, changes, it will be beta zero. For example, govt. treasury bond has no risk of market govt. treasury bond has no risk of market changes, these provide us same return.changes, these provide us same return.

2. Positive Beta: 2. Positive Beta: 

If any financial asset's return increases or decreases If any financial asset's return increases or decreases due to increasing or decreasing the market return, due to increasing or decreasing the market return, then this will the positive beta.then this will the positive beta.

  3. Negative Beta:3. Negative Beta:

If any financial asset's return decreases due to If any financial asset's return decreases due to increasing the market return or opposite relation increasing the market return or opposite relation between the both return, then it will be the negative between the both return, then it will be the negative beta.beta.

RISK FREE RATE (Rf)RISK FREE RATE (Rf) The theoretical rate of return of an investment with The theoretical rate of return of an investment with

zero risk. The risk-free rate represents the interest an zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free investor would expect from an absolutely risk-free investment over a specified period of time. investment over a specified period of time.

In theory, the risk-free rate is the minimum return an In theory, the risk-free rate is the minimum return an investor expects for any investment because he or investor expects for any investment because he or she will not accept additional risk unless the she will not accept additional risk unless the potential rate of return is greater than the risk-free potential rate of return is greater than the risk-free rate.rate.

In practice, however, the risk-free rate does In practice, however, the risk-free rate does not exist because even the safest not exist because even the safest investments carry a very small amount of investments carry a very small amount of risk. Thus, the interest rate on a three-month risk. Thus, the interest rate on a three-month U.S. Treasury bill is often used as the risk-U.S. Treasury bill is often used as the risk-free rate. free rate.

RETURN ON STOCKRETURN ON STOCK

Return on stock represents a combination of Return on stock represents a combination of dividends and increases in the stock price dividends and increases in the stock price (better known as capital gains).(better known as capital gains).

Return on Stock: Shareholder Total Return Return on Stock: Shareholder Total Return = Capital Gains + Dividends= Capital Gains + Dividends