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Beta

Beta records how volatile and risky investing in an individual stock is compared with the risk of the equity market as a whole. Beta measures how much the individual stock’s excess return (the amount it earns in dividends and capital gains compared with a short-term money market rate) varies in comparison with movement in the excess return of the market as a whole (usually represented by the market’s benchmark index). Beta compares excess return with short-term government paper because the latter investment is regarded as risk free. If the market’s excess return rises by one percent and the stock’s excess return rises during the same period by the same one percent then the stock’s beta is one. The higher the beta the riskier the stock, reflected in its greater required return. A stock with a beta of more than one tends to be riskier than the market. A stock with a beta of less than one is less risky. High beta stocks tend to be in cyclical sectors such as property and consumer durables. Low beta stocks, also known as defensive stocks, tend to be in non-cyclical sectors such as food retailing and public utilities. Betas for individual stocks can vary according to whether the overall market direction is upwards or downwards. A stock may be riskier in a falling market than a rising market.

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