Investment -- Meaning

Investment is the employment of funds on assets to earn income or capital appreciation. The individual who makes an investment is known as the investor. In economic terms, investment is defined as the net addition made to the capital stock of the country. In financial terms, investment is defined as allocating money to assets with a view to gain profit over a period of time. Investments in economic and financial terms are inter-related where an individual's savings flow into the capital market as financial investment, which are further used as economic investment.

Characteristics of Investment
Return : Investment are made with the objective of deriving a return. Return may be received in the form of yield plus capital appreciation. Dividend or interest received from the investment is the yield. Return from an investment depends upon the nature of the investment , the maturity period, etc., Risk : Risk is inherent in any investment . Risk may relate to loss of capital, delay in repayment of capital, non-payment of interest, or variability of returns. Government securities and bank deposits are riskless, other are more risky.

 Risk of an investment depends on the following factors: The longer the maturity period, the larger is the risk. The lower the credit worthiness of the borrower, the higher is the risk. Risk varies with the nature of investment. Investment in ownership securities like equity shares carry higher risk compared to investment in debt instruments like debentures and bonds. Safety : Safety of capital is the certainty of return on capital without loss of money or time involved. Investment avenue should be under the legal and regulatory frame work. Approval of the law itself adds a flavour of safety. Investors excepts to get back his capital on maturity without loss and without delay.

 Liquidity: A capital asset is easily realizable, saleable or marketable, it is said to be liquid. Portion of investment could be converted into cash without loss of time, it help the investor meet the emergencies. Marketability : Easy and quick means of transferability of an asset. Assets of listed companies and shares of public limited companies are more easily transferable than those of non-listed companies and private limited companies.

Why investment are important?

Longer life expectancy: Earnings from employment should be calculated that a portion should be put away as savings. Savings do not increase wealth, these must be invested in such a way that the principal and income will be adequate for a greater number of retirement years. Increase in working population, proper planning for life span and longevity have ensured the need for balanced investments. Increasing rates of taxation: Taxations is a crucial factors in any country which introduces an element of compulsion, in a persons savings. Benefits in tax accrue out of investment in Unit Trust Certificates, Unit Linked Insurance Plan, Life Insurance, National Savings Certificates, Post Office Cumulative Deposit Schemes etc.

 Interest Rates: It is necessary for a sound investment plan, the level of interest rates. It may vary between risky and safe investments, they may also differ due to different benefit scheme offered by the investments. Stability of interest is as important as receiving a high rate of interest. Inflation : Before funds are invested, erosion of the resource will have to be carefully considered in order to make the right choice of investment. The investor will try and search an outlet which gives him a high a rate of return in the form of interest to cover any decease due to inflation. Coupled with high rate of interest, he will have to find an outlet which will ensure safety of principal.

 Income : Investment decision have assumed importance is the general increase in employment opportunities in India. New organizations and services came into being. Banking recruitment services, Indian administrative services, tourism , hotels, educations, etc., Employment opportunities gave rise to both male and female working force. More incomes and more avenues of investment have led to the ability and willingness of working people to save and invest their funds. Investment channels: The investor in his choice of investment will have to try and achieve a proper mix between high rate of return and stability of return to reap the benefits of both. Instruments available are Corporate Stock, Provident Fund, Life Insurance, Fixed Deposits in Corporate Sector, Unit Trust Schemes,etc

Difference between Investment and Speculation

Base
Risk

Investment

Speculation

Investment is considered to Speculation is considered as an involve limited risk and is involvement of funds of high confined to those avenues where risk. the principal is safe Purchase of securities is preceded Buying low and selling high by proper investigation and making a large capital gain is analysis and review to receive a associated with speculation. stable return over a period of time. A longer term fund allocation is A short-term holding is termed as investment. associated with trading for the quick turn is called speculation

Capital gains

Time

Difference between Investment and Gambling

Investment
Investment is an attempt to carefully plan, evaluate and allocate funds in various investable outlets which offer safety of principal, moderate and continuous return and long term commitment. Examples , Provident Fund, Life Insurance, Fixed Deposits in Corporate Sector,

Gambling
Gambling is quite the opposite of investment. It connotes high risk and the expectation of high returns. It consists of uncertainty and high stakes for thrill and excitement. Examples , horse racing, game of cards, lottery.

Difference between Investor and Speculator

Base Investor Speculator Time horizon Has a relatively longer planning Has a very short planning horizon (possibility, scope). His horizon. His holding period holding period is usually of one or may be few days to months. more than one year. Risk return Decision His risk is less. Attaches greater significance to fundamental factors and carefully evaluates the performance of the company. Uses his own funds. His risk is high. Attaches greater significance to market behaviour and inside information. Uses borrowed funds along with his personal funds.

Funds

Types of Investors
Investors may be two types namely (i) Individual (ii) Institutions. Individual Investor operate alongside. Individual investors are larger in number but their investable resources are comparatively smaller. Lack the skill to carry out extensive evaluation and analysis before investing. Do not have time and resources to engage in an analysis. Institutional investor in the investment arena. (field) Institutional investors are the organizations with surplus funds who engage in investment activities. Mutual funds, investment companies, banking and non-banking companies, insurance corporations are the organizations with large amounts of surplus funds to be invested in various profitable avenues.

 Institutional investors are fewer in number compared to individual investors. Their investable resources are much larger than individual investor. Institutional investors engage professional fund managers to carry out extensive analysis and evaluation of different investment opportunities. Investment activity tends to be more rational and scientific. Better chance of maximizing returns and minimizing risk. Professional investors and the unskilled individual investors combine to make the investment arena dynamic.

Factors favourable for investment

Legal safeguards: A stable government which frames adequate legal safeguards encourages accumulation of savings and investments. Investors will be willing to invest their funds if they have the assurance of protection of their contractual and property rights. In India the investors have the dual advantage of free enterprise and government control. Freedom, efficiency and growth are ensured from the competitive forces of private enterprise. In India the political climate is conducive to investment as government control lends stability to the capital market. A stable currency: A well organized monetary system with definite planning and proper policies is a necessary prerequisite to an investment market.

 Most of the investments such as bank deposits, life insurance and shares are payable in a fixed amount of the currency of the country. A proper monetary policy will give direction to the investment outlets. A reasonable stable price level which is produced by wise monetary and fiscal management contributes towards proper control, good government, economic well-being and well disciplined growth-oriented investment market and protection to the investor. Existence of financial institutions to encourage savings: The presence of financial institutions which encourage savings and direct them to productive uses helps the investment market to grow. The financial institutions in existence in most countries are the commercial banks, life insurance companies and investment companies.

 In the united states there are investment bankers and mortgage bankers. Investment bankers are merchant of securities. They buy bonds and stocks of corporations and government bodies for re-sale to investors. Mortgage bankers sometime act as merchants and sometimes as agents on mortgage loans on residential properties. They serve as middlemen between investors and borrowers and perform collateral services in connection with loans. In India, the presence of a large number of financial institutions under central government and state government and rural bodies have encouraged the growth of savings and investment. For example life insurance corporation, unit trust of India. They offer a wide variety of schemes for savings and give tax benefits also.

 Form of Business Organization: Which is permanent in existence aides saving and investment. The public limited companies have been said to be the best form of organization. Three characteristics of the corporations which have been very useful for investors are limited liability of shareholders, perpetual life and transferability and divisibility of stocks and shares. The public limited company lends an element of liquidity to its shares by transferability of shares. The public limited company is a popular form for investment as the investors benefits from liquidity, convenience and longevity.

The Investment Process

The process of investment includes five stages: Investment Policy: The policy is formulated on the basis of investible funds, objectives and knowledge about investment sources. Investible funds: Availability of investible funds. Generated through savings or from borrowings Borrowed funds , investor has extra care in the selection of investment alternatives. Objectives: Required rate of return, need for regularity of income, risk perception and the need for liquidity. Risk takers objective is to earn high rate of return in the form of capital appreciation. Objective of risk averse is the safety of the principal.

 Knowledge : Investment alternatives range from security to real estate. Risk and return associated with investment alternatives differ from each other. Investment in equity is high yielding but has more risk than the fixed income securities. Tax sheltered schemes offer tax benefits to the investors. Investor should aware of the stock market structure and the functions of the brokers. Mode of operation varies among BSE, NSE, OTCEI. Brokerage charges are also different. Knowledge about the stock exchange enables him to trade the stock intelligently.

 Security Analyses: Economic, industry and company analyses are carried out for the purchase of securities. Market analysis: Stock market mirrors the general economic scenario. Growth in gross domestic product and inflation are reflected in the stock prices. Recession in the economy results in a bear market. Investors can fix his entry and exit points through technical analysis. Industry analysis: Industries that contribute major segments of the economy vary in their growth rates and their overall contribution to economic activity. Some industries grow faster than GDP and are expected to continue in their growth. Example, information technology. Economic significance and the growth potential of the industry have to be analyzed.

 Company analysis: Helps the investors to make better decisions. Company s earnings, profitability, operating efficiency, capital structure and management have to be screened. Appreciation of the stock value is a function of the performance of the company. Company with high product market share is able to create wealth to the investors in the form of capital appreciation. Valuation: Helps the investor to determine the return and risk expected from an investment in the common stock. Intrinsic value of the share is measured through book value of the share and P/E ratio. Future value of the securities could be estimated by using a simple technique like trend analysis. Analysis of historical behaviour of the price enables the investor to predict the future value.

Portfolio Construction: Portfolio is a combination of securities. To meet investors goals and objectives. Portfolio is diversified to maximize return and minimize risk. Diversification : Reduction of risk in the loss of capital and income. Diversified portfolio is comparatively less risky than holding a single portfolio. Debt and equity diversification: Debt instrument provide assured return with limited capital appreciation. Common stock provide income and capital gain but with the flavour of uncertainty. Both debt instruments and equity are combined to complement each other.

 Industry Diversification: Industries growth and their reaction to government policies differ from each other. Banking industry shares may provide regular returns but with limited capital appreciation. Information technology stock yields high return and capital appreciation but their growth potential is not predictable. Industry diversification is needed and it reduces risk. Company diversification: Securities from different companies are purchased to reduce risk. Technical analyst suggest the investors to buy securities based on the price movement. Fundamental analyst suggest the selection of financially sound and investor friendly companies.

 Selection: Based on diversification level, industry and company analyses the securities have to be selected. Selection of securities and the allocation of funds and seals the construction of portfolio. Portfolio Evaluation: The performance of the portfolio is appraised and revised. Appraisal: Return and risk performance of the security vary from time to time. Variability in returns of the securities is measured and compared. Appraisal warns the loss and steps can be taken to avoid such losses Revision : Low yielding securities with high risk are replaced with high yielding securities with low risk factor. To keep the return at a particular level necessitates the investor to revise the components of the portfolio periodically

Securities --Meaning

They are instruments which represent a claim over an asset or any future cash flows. Securities are classified on the basis of return and source of issue. Fixed income securities

Return

Variable income securities

Issuers Government Quasi-Government Public Sector Enterprises Corporates

Types of securities
Preference Stock - Meaning
Preference stock provides fixed rate of return. Preference stockholders do not have any voting rights. Like the equity, it is a perpetual liability of the corporate. Preference stockholders do not have any share in case the company has surplus profits. There are different types of preference stocks, they are: Cumulative and Non-cumulative preference shares Participating and non-participating preference shares Redeemable and non-redeemable preference shares Convertible and non-convertible preference shares

 Cumulative and Non-cumulative preference shares: Cumulative preference shares have the right of dividend of a company even in those years in which it makes no profit. The preference shares are non-cumulative in nature they do not have a share in the profits of the company in the year in which the company does not make profit. Participating and non-participating preference shares: Participating preference shares get a share of dividends over and above the share of dividends received at a fixed rate yearly. Preference share are non-participating in nature and do not receive a share higher than that fixed amount unless it is specifically stated at the time of the issue of shares.

 Convertible and non-convertible preference shares A convertible preference share is to be evaluated both as a preference share as well as an equity stock. It has the advantage of receiving a stable income in the beginning few years and then the conversion into an equity stock. Non-convertible preference shares do not enjoy the same status as a convertible stock. It is issued with features of participation in the dividends and may also be cumulative in nature, and may also be redeemable. Redeemable and non redeemable shares: Redeeming the preference shares after a certain number of years. Redeemable quality integrates its rate in the market because it is considered a stable form of return and also hedge against inflation and purchasing power risk. Non-redeemable means like the common stock its existence is permanent in nature and its shareholding is continuous till the liquidation of the company.

Equity Shares - Meaning

Common stock or ordinary shares are most commonly known as equity shares. Stock is a set of shares put together in a bundle. A share is a portion of the share capital of a company divided into small units of equal value. The advantages of equity shares are: Easily transferable:-- equity stock may be purchased and sold in the stock market immediately after purchase. Transferability gives the stockholder a right of purchasing as well as transferring his shares at will. Transferability gives the shareholder a right of using the stock as a collateral in banks for obtaining loans. Investment in equity share becomes widespread rather than limited because of easy transfer.

 Liability: shareholder has the right of being the owner of the firm his liability is limited only to the extent of his investment. It is very rare that the equity stockholder is called to pay an amount either during dissolution, reassociation or re-construction of a firm. Profit potentiality : an investor can hope for a price appreciation and rise in the value of his equity stock. A risk attached to the price appreciation. Profit potential is maximum in equity stocks the risk of loss and the danger of being in the red or having a minus value is even greater. Purchasing power risk: equity stock is considered a highly risky investment but it is considered safe from the point of view of purchasing power risk. Purchasing power risk is minimized because these are easily transferable and can be sold depending on the market value of the shares.

Sweat Equity --Meaning

It is a new equity instrument introduced in the Companies (Amendment) Ordinance, 1998. It forms a part of the equity share capital as its provisions, limitations and restrictions are same as that of equity shares. Sweat Equity is for: The directors or employees involved in the process of designing strategic alliances. The directors or employees who have helped the company to achieve a significant market share.

 Non-voting Shares Meaning: The shares that carry no voting rights are known as non-voting shares. They provide additional dividends in the place of voting rights. They can be listed and traded on the stock exchanges. Bonus Shares Meaning: Distribution of shares, in addition to the cash dividends, to the existing shareholders are known as bonus shares. These are issued without any payment for cash. These are issued by cashing on the reserves of the company. A company builds up its reserves by retaining part of its profit over the years.

 It is a debt instrument issued by a company, which carries a fixed rate of interest. It is generally issued by private sector companies in order to acquire loan. The various features of a debenture are: Interest Redemption Indenture (agreement, treaty) Types of debentures: Secured or unsecured debenture: Secured debenture is secured by a lien on the company specific assets. In the case of default the trustee can take hold of the specific asset on behalf of the debenture holders. Secured debentures have a charge on the present and future immovable assets of the company.

Debenture -- Meaning

 Debenture are not protected by any security they are known as unsecured or naked debentures. Unsecured debenture find it difficult to attract investors because of risk involved. Fully convertible debenture(FCD): debenture is converted into equity shares of the company on the expiry of specific period. FCD carries lower interest rate than other types of debentures because of the attractive feature of convertibility into equity shares. Partly convertible debenture: consists of two parts namely convertible and non-convertible . Convertible portion can be converted into shares after a specific period. The investor has the advantage of convertible and non-convertible debentures blended into one debenture.

 Non-convertible debenture: Non-convertible debentures do not confer any option on the holder to convert the debentures into equity shares and are redeemed at the expiry of the specified period.

Bond -- Meaning
A bond is a debt security issued by the government, quasigovernment, public sector enterprises and financial institutions. Features of a bond are: It is traded in the securities market The interest rate is generally fixed At the time of issue of bonds, maturity date is specified Types of bonds: Secured bonds and unsecured bonds Perpetual bonds and redeemable bonds Fixed interest rate bonds and floating interest rate bonds Zero coupon bonds

Warrants -- Meaning
A warrant is a detachable instrument, which gives the right to purchase or sell equity shares at a specified price and period. It is traded in the securities market where the investor can sell it separately. Types of warrants are: Detachable warrants: When the warrants are issued along with host securities and detachable, then they are known as detachable warrants. Puttable warrants: Represent a certain amount of equity shares that can be sold back to the issuer at a specified price, before a stated date. Advantages of warrants are: They have limited risk. They offer potential for unlimited profits. They can be traded in the securities market.

Concept of Investment Alternatives

Investment alternatives mean investment in assets other than the shares or debentures of a company. The alternatives range from financial securities to traditional nonsecurity investments. The financial securities may be negotiable or non-negotiable securities. The financial securities that are transferable are known as negotiable securities. Negotiable securities can be of two types: Variable income securities :-- Equity shares Fixed income securities :-- Debentures, Bonds, Kisan Vikas Patras, Indira Vikas Patras and Government securities.

 Non-negotiable Securities: The financial securities that are not transferable are known as nonnegotiable securities. They are also known as non-securitized financial investments. The deposit schemes that are offered by the post offices, banks, companies, etc. form a part of the non-negotiable securities. Deposit facility is offered by banks and post offices. Real Assets Real assets are tangible assets, which include: Gold and silver Real estate Art (painting, drawing) Antique items (very old, traditional)

Fixed Income Securities

Fixed income securities are the financial claims with promised cash flows of fixed amounts, paid at fixed dates. Fixed income securities are classified as: Preference shares: Refer to the shares that provide a fixed rate of dividend to the preference shareholders. Debentures: Refer to a long term debt instrument issued by corporate entities to acquire finance. Bonds: Refer to a debt security issued by the government, quasi-government, public enterprises and financial institutions. Government securities: Refer to the securities that are issued by the Central, State and quasi-government agencies. Money market securities: Refer to the securities that have a very short term maturity period.

Tax Sheltered Savings Schemes

Types of tax sheltered savings schemes are: Public Provident Fund Scheme: It provides yearly interest which is exempted from income tax under Section 88. National Savings Scheme: It provides 100 per cent tax rebate to the depositors. National Savings Certificate: It is a scheme provided by the post offices for a period of six years. Once money is deposited, no withdrawals are permitted, but loans can be taken.

Life Insurance
It is an agreement made between the insurance company and the insured person. The insurance company has to pay a certain amount of money on the occurrence of the event insured against. Advantages of life insurance are: Protection Liquidity Easy payments Tax relief on specified schemes

Mutual Funds
These are professionally managed portfolios of securities. Mutual Fund is classified into two: Open-ended schemes:-- these offer their unit on a continuous basis. Repurchase is also carried out on a continuous basis. It is not traded in the stock exchange. Close ended schemes: These are schemes in which the number of units are fixed and are traded in the stock exchange. The factors to be considered in the selection of mutual funds are: Net assets Income composition Portfolio composition Expense ratio

 What causes the risks? Wrong decision of what to invest in. Wrong timing of investment. Nature of the instruments invested say, the category of assets like corporate shares or bonds, chit funds etc., are highly risky and unorganized sector. Bank deposit , P.O. Certificate are less risky and organized sector. Creditworthiness: securities of government and semi-government are more creditworthy than those issued by the corporate sector. Maturity period or the length of investment: longer the period, the more risky is the investment normally. Amount of investment: higher the amount of invested in any security the larger is the risk. Method of investment namely secured by collateral or not. Terms of lending such as periodicity of servicing, redemption period. Nature of industry or business in which the company is operating.

Concept of Risk
Risk is expressed in terms of variability of return. An investor before investing in securities must properly analyze the risks associated with these securities. There are two types of risks: Systematic risk Unsystematic risk Systematic risk: It is the risk that is caused by external factors such as economic, political and sociological conditions. It affects the functioning of the entire market. They are of three types: Market risk Interest rate risk Purchasing power risk

Market Risk
Jack Francis has defined market risk as that portion of the total variability of returns that is caused by the alternating forces of bull and bear markets. When the stock market moves upwards, it is known as bull market. On the other hand, when the stock market moves downwards, then it is known as bear market. The two forces that affect the market are: Tangible events: Earthquake, war, political uncertainty and decrease in the value of money are some of the examples of tangible events. Intangible events: It is related to market psychology. Political unrest or fall of government affects the market sentiments.

Interest Rate Risk

It is the risk caused by the variations in the market interest rates. Prices of debentures, bonds, etc. are mainly affected by the interest rate risk. The causes of interest rate risk are as follows: Changes in the governments monetary policy Changes in the interest rate of treasury bills Changes in the interest rate of government bonds

Purchasing Power Risk

Variations in returns are caused by the loss of purchasing power of currency. There are mainly two types of inflation: Demand-pull inflation: The demand for goods and services remains higher than the supply. Cost-push inflation: There is a rise in price due to the increase in the cost of production.

Nominal future value Real future value = 1.0 Inflation Rate 1.0 r Real Rate of Return = 1.0 1.0 IR
where r = rate of return IR = Inflation Rate

 It is a type of risk which is unique, specific and related to a particular industry. Managerial inefficiency, changes in preferences of the consumers, availability of raw material, labour problems, etc. are some of the causes of unsystematic risk. These are of two types: Business risk Financial risk Business risk: It is the risk that is caused by the inefficiency of a company to manage its growth or stability of earnings. It can be classified as: Internal business risk: It is the risk that is associated with the operational efficiency of a company. External business risk: It is the risk that is the result of operating conditions imposed on the firm by the external environment.

Unsystematic Risk

 It is associated with the capital structure of the company, which consists of equity and borrowed funds.
A financial risk can be avoided by analyzing the capital structure of the company.

Financial Risk

The financial risk considers the risk between EBIT and EBT.
The payment of interest affects the eventual earnings of the company. Default or insolvency risk:

Borrower's credit rating might have fallen suddenly and he became default prone and in its extreme form it may lead to insolvency or bankruptcies.
Investor may get no return or negative returns. Investment in a healthy companys share might turn out to be a waste paper. By the deliberate mistakes of management or acts of god the company became sick and its share price tumbled below its face value.

Measurement of Risk
An intelligent investor would attempt to anticipate the kind of risk that he is likely to face. He tries to measure or quantify the risk of each investment that he consider before making the final selection. Risk in investment is associated with return. The risk of an investment cannot be measured without reference to return. The return depends on the cash inflows to be received from the investment. Suppose a share is currently selling at Rs.1200. an investor who is interested in the share anticipates that the company will pay a dividend of Rs.50 in the next year. Moreover, he expects to sell the share at Rs.1750 after one year. The expected return from this investment can be calculated as follows:

 R = Forecasted dividend + Forecasted end of the period stock price --------------------------------------------------------------------------- -1 initial investment R = Rs.50 + Rs.1750 -------------------- -1 = 0.5 or 50% Rs. 1200 The investor expects to get a return of 50% in the future. But the future is uncertain. The dividend declared by the company may turn out to be either more or less than the figure anticipated by the investor. The selling price of the stock may be less than the price anticipated by the investor at the time of investment. It may sometimes be even more. There is a possibility that the future return may be more than 50% or less 50%.

 Expected return: The expected return of the investment is the probability weighted average of all possible returns. If the possible return are denoted by Xi and the related probabilities are p(Xi), the expected return may be represented as X and can be calculated as

p ( )

Risk : Expected returns are insufficient for decision-making. The risk should also be considered . The most popular measure of risk is the variance or standard deviation of the probability distribution of possible returns. Variance is denoted by sigma square and is calculated by the following formula:

=
=

[( ) ( )]

Standard deviation is the square root of the variance and is represented as sigma . The variance and standard deviation measure the extent of variability of possible returns from the expected return. The standard deviation or variance provides a measure of the total risk associated with a security. Total risk comprises of two components, namely systematic risk and unsystematic risk. Unsystematic risk is risk which is specific or unique to a company. Unsystematic risk associated with the security of a particular company can be reduced by combining it with another security having opposite characteristic. This process is known as diversification of investment.

 Measurement of systematic risk: Systematic risk is the variability in security returns caused by changes in the economy or the market. The systematic risk of a security can be measured by relating that securitys variability with the variability in the stock market index. The systematic risk of a security is measured by a statistical measure called Beta. The input data required for the calculation of beta are the historical data of returns of the individual security as well as the returns of a representative stock market index. Two statistical methods may be used for the calculation of beta, namely the correlation method or the regression method.

 Correlation method Beta can be calculated from the historical data of returns by the following formula:

=
2
= correlation coefficient between the returns of stock i and returns of the market index. = Standard deviation of returns of stock i. = standard deviation of returns of the market index.
2 = Variance of the market returns.

Regression method: The regression model postulates a linear relationship between a dependent variable and an independent variable. The model helps to calculate the values of two constants, namely and Alpha and Beta

 Beta measures the change in the dependent variable in response to unit change in the independent variable. Alpha measures the value of the dependent variable even when the independent variable has Zero values. The distance between the inter-section and the horizontal axis is called Alpha. It indicates that the stock return is independent of the market return. A positive value of alpha is a healthy sign. The form of regression equation is as follows:

Y = +
Where Y= Dependent variable X= Independent variable are constants

2 (

)2

n = Number of items Y = Mean value of the dependent variable scores. X = Mean value of independent variable scores. y = dependent variable scores. x = independent variable scores. Beta measures the volatility of a security returns relative to the market, the larger the beta, the more volatile the security. A beta of 1.0 indicates a security of average risk. A stock with beta greater than 1.0 has above average risk.

 Calculation of beta, the return of the individual security is taken as the dependent variable, and the return of the market index is taken as the independent variable. The regression equation is represented as follows:

= Return of the market index. = . = estimated return of the security when the market is stationary = Return of the individual security.

 Its returns would be more volatile than the market return. For example, when market return move up by five per cent, a stock with beta of 1.5 would find its returns moving up by 7.5 per cent (i.e. 5x1.5). Similarly, decline in market returns by five per cent would produce a decline of 7.5 per cent in the return of the individual security. A stock with beta les than 1.0 would have below average risk. Variability in its returns would be comparatively lesser than the market variability. Beta can also be negative, implying that the stock returns move in a direction opposite to that of the market returns.

Beta
Beta is the slope of the regression line.

Beta describes the relationship between the stock return and index return.
Beta = +1.0. One per cent change in index return causes one per cent change in stock return. Beta = +0.5. One per cent change in index return causes 0.5 per cent change in stock return. Negative beta indicates that the stock return and the market move in opposite directions.