Beta[1]
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  • 1. Beta “ What Is Beta and How Is It Calculated?” or….
  • 2. Beta
    • A “coefficient measuring a stock’s relative volatility”
    • Beta measures a stock’s sensitivity to overall market movements
    Source:UBS Warburg Dictionary of Finance and Investment Terms
  • 3.
    • 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
    • The S&P 500 index has a beta of 1
  • 4. A Generic Example
    • Stock XYZ has a beta of 2
    • The S&P 500 index increases in value by 10%
    • The price of XYZ is expected to increase 20% over the same time period
  • 5. Beta can be Negative
    • Stock XYZ has a beta of –2
    • The S&P 500 index INCREASES in value by 10%
    • The price of XYZ is expected to DECREASE 20% over the same time period
  • 6.
    • If the beta of XYZ is 1.5 …
    • And the S&P increases in value by 10%
    • The price of XYZ is expected to increase 15%
  • 7.
    • A beta of 0 indicates that changes in the market index cannot be used to predict changes in the price of the stock
    • The company’s stock price has no correlation to movments in the market index
  • 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. Beta and Risk
    • Beta is a measure of volatility
    • Volatility is associated with risk
  • 10. Risk-Reward Curve Risk Expected Return
  • 11.
    • 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
    • What does this remind you of?
  • 12. Beta and CAPM
    • The capital asset pricing model:
    • E(R) = Rf + B(Rm-Rf)
    • where:
    • E(R) = Expected return
    • Rf = risk free rate of return
    • B = beta
    • Rm = market return
  • 13. WACC
    • Weighted average cost of capital:
    • WACC = (D/V)*Rd*(1-T) + (E/V)*Re
    • where:
    • D = market value of firm’s debt
    • Rd = return on debt securities
    • T = tax rate
    • E = market value of firm’s equity securities
    • Re = return on equity securities (from CAPM)
    • V = total value of firm’s securities (D + V)
  • 14. WACC and Beta
    • WACC increases as the beta and the rate of return on the equity securities increases (all else constant)
    • WACC is used as the discount rate in DCF models
    • Therefore, increasing WACC reduces the firms valuation to reflect the increase in risk
  • 15. How to Calculate Beta
    • Beta = Covariance(stock price, market index)
    • Variance(market index)
    • **When calculating, you must compare the percent change in the stock price to the percent change in the market index**
  • 16. How to Calculate Beta
    • Easily calculated using Excel and Yahoo! Finance
    • Use COVAR and VARP worksheet functions
    • An example:
    • Calculate the beta of Citigroup stock over the 5-yr time period from Jan. 1, 1997 – Dec. 31, 2001
  • 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