Beta- Analyzing mutual funds

Guru Prasad -

 The risk of any investment made always depends on the volatility in the following investment. If we can have a factor that could tell us about the volatility of a investment and help us judge our risk and corelate it with our capability to take risk, how would that be? Well Beta factor is one such factor that could help us know the sensitivity of our stock or portfolio fund that we have chosen to invest.

Beta ratio:-

Understanding Beta:-

 Beta is a metric used in fundamental analysis to determine the volatility of a stock with comparison to the overall market that has a fixed beta ratio of 1 always. Stocks or funds that are ranked with a beta ratio above 1 generally tend to fluctuate more and hence give access to more risk but yielding higher returns too at the same time if gone in favour. While the risk is slightly less in the funds with beta ratio below 1 they give less but yet stable return on investments generally. Hence, the beta factor can be said as a risk- reward factor, helping a person to judge his risk taking ability for a particular return. 

How Beta is Calculated?

Before understanding the calculation of  Beta first let us learn about what is covariance and variance.

Variance is the measure of how far the market moves relative to its mean and covariance is the measure of that stocks return in relative to that of the market. In simple words variance measures the volatility of a single stock while the covariance measure the correlation in price moves of two different stocks.

Beta= covariance/variance

Now, to calculate beta we shall take the ratio of covariance of the stock to that of the variance of the market. 

Hence, Beta= Covariance/Variance

Studying Beta:-

Let us assume that a stock has a beta factor of 1.70 then the stock would be considered very highly volatile as it has a 70% higher volatility then the market. Hence until and unless the other fundamentals of this stock are not great it could be risky to invest too.




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