10.3.1. Beta
Beta is essentially a measure of correlation, or how two items fluctuate in relation to one another. In this case, we are looking at the correlation between the performance of a single security and the performance of the market as a whole.
Looking at the previous formula, suppose a security’s beta equals 1.0. The expected return of that security will be identical to the expected return of the market. In other words, the security can be expected to fluctuate by the same percentage the market fluctuates. A beta greater than 1.0 indicates that the price of the security will move more than the market. A beta of less than 1.0 indicates that the price of the security will move less than the market. For example, if the market rose 10% and a particular stock has a beta of 2.0, the stock’s price would be expected to increase 20%. If another stock has a beta that is 0.5, it would be expected to only increase by 5%.
Note: It is important to recognize two unique situations. First, if a stock has a beta of 0, it means there is no relationship between how its price fluctuates and the fluctuation of the market. Second, if a security has a negative beta (for example, -1.0 or -0.5), it means it moves in the oppos