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Beta “ What Is Beta and How Is It Calculated?” or….
Beta <ul><li>A “coefficient measuring a stock’s relative volatility” </li></ul><ul><li>Beta measures a stock’s sensitivity...
<ul><li>In practice, Beta is measured by comparing changes in a stock price to changes in the value of the S&P 500 index o...
A Generic Example <ul><li>Stock XYZ has a beta of 2 </li></ul><ul><li>The S&P 500 index increases in value by 10% </li></u...
Beta can be Negative <ul><li>Stock XYZ has a beta of –2 </li></ul><ul><li>The S&P 500 index INCREASES in value by 10% </li...
<ul><li>If the beta of XYZ is 1.5 … </li></ul><ul><li>And the S&P increases in value by 10% </li></ul><ul><li>The price of...
<ul><li>A beta of 0 indicates that changes in the market index cannot be used to predict changes in the price of the stock...
Company Beta AMGN 0.82 BRK.B 0.73 C 1.37 XOM 0.10 MSFT 1.80 MWD 2.19 NOK 2.05 PXLW 1.93 TXN 1.70 VIA.B 1.39
Beta and Risk <ul><li>Beta is a measure of volatility </li></ul><ul><li>Volatility is associated with risk </li></ul>
Risk-Reward Curve Risk Expected Return
<ul><li>If beta is a measure of risk, then investors who hold stocks with higher betas should expect a higher return for t...
Beta and CAPM <ul><li>The capital asset pricing model: </li></ul><ul><li>E(R) =  Rf + B(Rm-Rf) </li></ul><ul><li>where: </...
WACC <ul><li>Weighted average cost of capital: </li></ul><ul><li>WACC = (D/V)*Rd*(1-T) + (E/V)*Re </li></ul><ul><li>where:...
WACC and Beta <ul><li>WACC increases as the beta and the rate of return on the equity securities increases (all else const...
How to Calculate Beta <ul><li>Beta =  Covariance(stock price, market index) </li></ul><ul><li>Variance(market index) </li>...
How to Calculate Beta <ul><li>Easily calculated using Excel and Yahoo! Finance  </li></ul><ul><li>Use COVAR and VARP works...
S&P 500 Adjusted Daily Closing Values: January 1, 1997 -  December 31, 1997 Citigroup Adjusted Daily Closing Prices: Janua...
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Beta[1]

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  1. 1. Beta “ What Is Beta and How Is It Calculated?” or….
  2. 2. Beta <ul><li>A “coefficient measuring a stock’s relative volatility” </li></ul><ul><li>Beta measures a stock’s sensitivity to overall market movements </li></ul>Source:UBS Warburg Dictionary of Finance and Investment Terms
  3. 3. <ul><li>In practice, Beta is measured by comparing changes in a stock price to changes in the value of the S&P 500 index over a given time period </li></ul><ul><li>The S&P 500 index has a beta of 1 </li></ul>
  4. 4. A Generic Example <ul><li>Stock XYZ has a beta of 2 </li></ul><ul><li>The S&P 500 index increases in value by 10% </li></ul><ul><li>The price of XYZ is expected to increase 20% over the same time period </li></ul>
  5. 5. Beta can be Negative <ul><li>Stock XYZ has a beta of –2 </li></ul><ul><li>The S&P 500 index INCREASES in value by 10% </li></ul><ul><li>The price of XYZ is expected to DECREASE 20% over the same time period </li></ul>
  6. 6. <ul><li>If the beta of XYZ is 1.5 … </li></ul><ul><li>And the S&P increases in value by 10% </li></ul><ul><li>The price of XYZ is expected to increase 15% </li></ul>
  7. 7. <ul><li>A beta of 0 indicates that changes in the market index cannot be used to predict changes in the price of the stock </li></ul><ul><li>The company’s stock price has no correlation to movments in the market index </li></ul>
  8. 8. Company Beta AMGN 0.82 BRK.B 0.73 C 1.37 XOM 0.10 MSFT 1.80 MWD 2.19 NOK 2.05 PXLW 1.93 TXN 1.70 VIA.B 1.39
  9. 9. Beta and Risk <ul><li>Beta is a measure of volatility </li></ul><ul><li>Volatility is associated with risk </li></ul>
  10. 10. Risk-Reward Curve Risk Expected Return
  11. 11. <ul><li>If beta is a measure of risk, then investors who hold stocks with higher betas should expect a higher return for taking on that risk </li></ul><ul><li>What does this remind you of? </li></ul>
  12. 12. Beta and CAPM <ul><li>The capital asset pricing model: </li></ul><ul><li>E(R) = Rf + B(Rm-Rf) </li></ul><ul><li>where: </li></ul><ul><li>E(R) = Expected return </li></ul><ul><li>Rf = risk free rate of return </li></ul><ul><li>B = beta </li></ul><ul><li>Rm = market return </li></ul>
  13. 13. WACC <ul><li>Weighted average cost of capital: </li></ul><ul><li>WACC = (D/V)*Rd*(1-T) + (E/V)*Re </li></ul><ul><li>where: </li></ul><ul><li>D = market value of firm’s debt </li></ul><ul><li>Rd = return on debt securities </li></ul><ul><li>T = tax rate </li></ul><ul><li>E = market value of firm’s equity securities </li></ul><ul><li>Re = return on equity securities (from CAPM) </li></ul><ul><li>V = total value of firm’s securities (D + V) </li></ul>
  14. 14. WACC and Beta <ul><li>WACC increases as the beta and the rate of return on the equity securities increases (all else constant) </li></ul><ul><li>WACC is used as the discount rate in DCF models </li></ul><ul><li>Therefore, increasing WACC reduces the firms valuation to reflect the increase in risk </li></ul>
  15. 15. How to Calculate Beta <ul><li>Beta = Covariance(stock price, market index) </li></ul><ul><li>Variance(market index) </li></ul><ul><li>**When calculating, you must compare the percent change in the stock price to the percent change in the market index** </li></ul>
  16. 16. How to Calculate Beta <ul><li>Easily calculated using Excel and Yahoo! Finance </li></ul><ul><li>Use COVAR and VARP worksheet functions </li></ul><ul><li>An example: </li></ul><ul><li>Calculate the beta of Citigroup stock over the 5-yr time period from Jan. 1, 1997 – Dec. 31, 2001 </li></ul>
  17. 17. S&P 500 Adjusted Daily Closing Values: January 1, 1997 - December 31, 1997 Citigroup Adjusted Daily Closing Prices: January 1, 1997 - December 31, 1997
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