Question

What is a beta? how is it used to calculate r, the investor's required rate of return?

Answer 1

Beta is the volatility or systematic risk of the price of an asset in relation to the market as a whole is measured by as beta.

How and why beta is calculated?

• A beta of 1 means that the security's price moves in lockstep with the market and has the same level of volatility. A security is less volatile than the market if its beta value is less than one. A security is more volatile than the market if its beta value is greater than one.

The Capital Asset Pricing Model uses beta to determine the needed rate of return (CAPM).

The following formula is used to compute it:

Ke = Rf + b [ E ( Rm ) - Rf ]

Where:

Risk-free rate of return is Rf.

Rm stands for estimated market rate of return.

b = beta of a stock.

To learn more about rate of return, click the links.

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