CFP

Risk and Return Measures - Correlation and Volatility Statistics

  1. Beta (β) - Measures only systematic risk, e.g. that which is found in the market and not unique to a given investment. The market has a beta of 1. A stock or portfolio with a beta of 1.37 is 37% more volatile than the market. A stock with a beta of <1 is less volatile than the market. Betas for individual securities are not stable over time, but are within a portfolio as the individual betas' fluctuations tend to offset one another. Beta is an effective measure of total risk in a portfolio where unsystematic risk is eliminated through diversification.


Look Out!
Expect some questions on the interpretation of beta, its applications and its limitations.

  1. Covariance - A measurement of the extent to which two or more assets are correlated. The formula is expressed as follows:

Covariance=σAσBRAB

If the covariance between Stock I and Stock II is .0083 and their respective standard deviations are 37% and 9%, respectively, then their covariance is calculated as follows:

0.0083=(.37)(.09)(RI,II), then RI,II = .0083/{(.37)(.09)}=.092
  1. Semivariance - The average squared deviation below the mean, it is a risk measure that focuses only on the variability of returns below the average or expected return. It is used principally to measure the extent of downside risk.


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