UPSC Prelims 2023 Question:
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) 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
Correct Answer: Option d)
Learn more about the financial term beta in the given explanation below.
- Beta is a measure of a stock's historical volatility in comparison with that of a market index such as the S&P 500. Stocks with a beta above 1 tend to be more volatile than their index, while stocks with lower betas tend to be less volatile.
How does Beta Work?
- A beta above 1 means that the stock is more volatile than the market. This means that it will tend to move up and down more than the market. A beta below 1 means that the stock is less volatile than the market. This means that it will tend to move up and down less than the market.
- Investors can use beta to decide how much risk they want to take on. If they are looking for high returns, they may be willing to invest in stocks with high betas. However, they should be aware that these stocks are also more likely to lose value. If investors are looking for more stability, they may prefer to invest in stocks with low betas.
Here is an example of how to use beta:
- Suppose a stock has a beta of 1.3 and the NSE Nifty is expected to move up by 10%. This means that the stock is expected to move up by 13% (1.3 x 10%).
- Beta is also a key factor used in the Capital Asset Price Model (CAPM), which is a model that measures the expected return of a stock. The CAPM takes into account the stock's beta, the risk-free rate, and the expected return of the market.
- Overall, beta is a useful tool for investors to understand the risk of a stock. Investors can use beta to decide how much risk they want to take on and to select stocks that are appropriate for their investment goals.
Therefore, option (d) is the correct answer.
Subject: Economics| Financial Sectors and Capital Market
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