Q3. In the context of finance, the term ‘beta’ refers to
a. the process of simultaneous buying and selling of an asset from different platforms
b. an investment strategy of a portfolio manager to balance risk versus reward
c. a type of systemic risk that arises where perfect hedging is not possible
d. a numeric value that measures the fluctuations of a stock to changes in the overall stock market
Question from UPSC Prelims 2023 GS Paper
Explanation :
d. a numeric value that measures the fluctuations of a stock to changes in the overall stock market
Beta in Stock Market Analysis
Beta is a measure of a stock’s volatility in relation to the overall market. It plays a crucial role in the Capital Asset Pricing Model (CAPM), a model used to calculate the expected return of an asset, considering its risk compared to the market.
Understanding Beta Values
A beta value of 1 suggests that the stock’s movement is in line with the market. A beta greater than 1 indicates higher volatility than the market, while a beta less than 1 shows lower volatility.
Investors utilize beta to gauge the risk of a stock and to construct diversified portfolios that balance risk and reward. Stocks with high beta are associated with higher returns and risk, whereas low-beta stocks are linked to lower returns and reduced risk.Practical Example
For instance, a stock with a beta of 1.5 implies that it is expected to change by 1.5% for every 1% change in the market. This is critical for investors in making informed investment choices and portfolio construction.