Topic 29
Beta
Beta is a measure that captures the systematic risk of a security in the construction of the cost of equity capital determined with the capital asset pricing model (CAPM), as introduced in Topic 23.
BETA IS AND IS NOT
- In portfolio theory, because investors can hold large diversified portfolios of securities, unsystematic risk (general business risk) can be diversified away across the portfolio. (Factors that drive values up in some securities will drive values down in other securities.)1
- The specific unsystematic risk of a security can therefore be ignored when considering adding it to a large investment portfolio.2
- The impact of unsystematic business risks on the valuation of an acquisition target are best dealt with by modeling the potential economic impact of those events that can create variation in returns.
- Other risks of equity ownership not controllable by management that cannot be diversified away—so-called systematic risk—must also be evaluated in valuing an equity investment.
- Beta, central to the CAPM (see Topic 23), is employed to do this.
- Beta measures the systematic risk (volatility) exhibited by a security as it moves sympathetically with the securities markets as a whole.3
- Beta is a computationally derived measure of how much a securities market value increases or decreases (its volatility) versus the increase or decrease in the securities market as a whole.
- The Standard & Poor's (S&P) 500 stock market index has a beta of 1.0.4
- A beta of 1.10 for ...
