Beta

The beta value of a share reflects the correlation and volatility of the share compared to the wider market. If over a given period a share rises 100%, but the market only rises 50% then the beta of the share is two, the share being more volatile than the market. Equally if a share moves only half the percentage move in the market in a given period, the beta is 0.5 with the share being less volatile than the market. If the share price moves in the opposite direction (inversely correlated) to the market the beta would be quoted as a negative number. beta can also be zero, which would indicate that there was no correlation to the market, either positive or negative.

This measure can be used to forecast share prices. For example a method of estimating a price for equity would be to calculate the discounted future cash flows into the company from which a company value, and hence share price could be determined. In order to calculate an appropriate discount rate you could use beta as follows. Assuming a safe 'risk free' yield from cash or bonds is 4%, and assuming the equity risk premium of investing in equities is also 4%, then an discount rate could be calculated as

Discount Rate = 'Risk free yield' + beta * 'equity risk premium'

This takes account of the volatility of the company compared to the market. So if the company has a beta of 2, the discount rate applied to future cash flows would be 4% + 2 * 4% = 12%.

What to do if you need more help

If you need more help with your specific commercial loan, mortgage or insurance requirement please speak to a professional financial adviser.

We hope you found this information useful.

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