Question

Describe what beta is, how is it measured, and why it affects a stock's expected return.

Answer 1

Beta is the sensitivity of a stock to the returns of the market. The higher the beta, the higher is the sensitivity of a stock to changes in the market.

The beta coefficient is calculated by dividing the covariance of the stock return versus the market return by the variance of the market.

The stock's return in affected by the beta, the higher the beta he higher will be the expected return of a security as the investor has to be compensated for the systematic risk that the investor is exposed to.

The expected return as demonstrated by the CAPM :

Re = Rf + beta (Rm - Rf)