ShmoopTube

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principles of finance a la shmoop what is bata bata yeah you know bata

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it's the Greek letter the one that looks like a capital B with a fancy tail there [Beta symbol appears]

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well the symbol that more or less represents risk in an investment and no

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it's not this guy who puts anchovies on a hook outside Boston Harbor before [man fishing for anchovies]

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hunting wicked tuna you know beta since risk is such a big

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deal in the land of investing it gets its own symbol and the concept is pretty

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easy the more beta or risk you have in a given project while the more likely that

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the financial rewards around it will vary like they could be really good or

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really bad but beta isn't just about variation in the returns on the

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investment so how is beta tied to the behavior of the market in general but

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when the markets bouncing around up and down like a hyper kangaroo trying to [kangaroo bouncing]

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give birth on a trampoline there the returns on an investment with a large

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beta will probably also vary wildly beta is greater than 1 very to a larger

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degree than the overall market and betas of stocks with less than one very last

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like that's the code a beta with a 1 basically is the market so if the

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markets S&P 500 and your stock always goes up 1% when the market goes up 1%

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and it goes down 1% when the market goes down 1% well it's probably that your

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stock isn't really a stock it's an index fund like ticker s P Y or something like

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that yeah that's what happens when the markets acting like a toddler who lost [toddler alone moaning]

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his mommy but found some candy and then lost the candy but found a kitten that

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was from Todd go up the returns on an investment with a small beta will still [toddler holding cat]

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experience some variation just a lot less than the large beta investment

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there ok God all that well in order for a beta value to be helpful and decently

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predictive it must be highly correlated to a specific market trivia note

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correlation is referred to as an R value and a high r-squared value implies

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something is highly correlated whereas a low r-squared value means it's not very [high and low r-squared value meanings appear]

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correlated meaning it if you decided to dump all your cash in orange juice

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futures and you want a beta that actually helps you decide how risky your

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investment might be well your beta should be calculated using a produce

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commodities market as a benchmark and not a market for tech stocks or gold

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bullion or publicly-traded flyswatter companies

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you'd say that orange juice futures have a high

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r-squared correlation with the benchmark of commodities of frozen concentrated [orange juice and grapefruit juice appears]

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grapefruit juice it seems kind of obvious that we should compare our

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investment of choice to other similar investments but it was also supposed to

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be obvious that using hydrogen in the Hindenburg was a really stupid idea so [hindenburg exploding]

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you know go figure so what values can we expect for beta and what do they mean a

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beta value of 1 means the returns on the investment are exactly correlated to the

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swings in whatever the comparative market is that you're relating it to

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meaning that if the market increases 10% in value the returns increase exactly

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10% as well like ticker s P Y and the actual S&P 500 right ticker s P Y is an

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index fund that mostly Apes the production of the S&P 500 but it isn't [S&P 500 chart appears]

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actually the S&P 500 a beta value greater than 1 like 1 point 3 for

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example means that the investment will vary about 30 percent more than the

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market does that beta of 1.3 specifically means the returns on the

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investment will probably vary 30 percent more on any given day or any given

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period of time or any given period average of say days closing prices over

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the last 90 or 150 days or something like that so you've got to be specific

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about what the numbers are comparing and what period of time you're looking at in [Person looking into rear view mirror]

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the rearview mirror here when you do these counts a beta less than 1 means

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the returns on the investment are less variable then the corresponding swings

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in the market a beta of 0.75 means the returns on the investment will vary

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about 25% less than the market like on a day that the markets up 1% well your

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investment there's probably only gonna be up point 7 5 percent but same deal on

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the downside and a beta of zero means there's no correlation between the

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variability of your investment in the market like that mattress our grandpa [money stashed under mattress]

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had stuffed full of $20 bills well it's investment return value is going to stay

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put at zero pretty much no matter what happens to the market we've been beating

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the beta bongos pretty hard here so let's recap a bit beta is a measure of [person beating bongos]

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how much the returns on investment are likely to change when the market changes

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a low beta under one means the returns will probably vary less than the market

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high beta over 1 means they vary more well useful betas are always calculated

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against it's the trade or track investments of

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similar types so you might ask yourself well what would an example be of a low

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beta company well that would be one that maybe was trading for 30 bucks a share

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but it had 18 dollars a share in cash on it so if the market went up a lot or

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went down a lot you always had that 18 dollars it's kind of the equivalent of

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grandpa's $20 bills in his mattress there you know that guy so that happens [grandpa lays on mattress]

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that's kind of what stabilizes the market having a lot of cash and you can

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flip that if a company had net debt not net cash meaning a lot of debt like say

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500 million dollars are dead on only a hundred 50 million dollars of cash flow

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well then if the market moves up or down that company's going to move many many

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times more beta than the market would move and while these betas seem kind of

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random and we're just throwing out numbers for direct investing in just a

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stock they kind of help maybe they whisper in your ear they sort of mean [person whispers into an ear]

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something where they really come in handy is when you're trading derivatives

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or thinking about put and call options in and around stocks and bonds because

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then the risk premium of those options is all priced basically driving right

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from beta or their perceived risk in the stock and if you get the risk better

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than the street does well you can make a killing yeah so the next time you're at [people working in wall street]

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one of those investment parties we hear so popular you know the ones where

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people get together in to buy and sell stocks wait that's just a trading floor

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isn't it all right not an investment party huh and we bought chips and dip

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anyway when you're partying on the trading floor and looking for a way to [People partying on trading floor]

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manage risk well make sure you invite the beta for each of those stocks you're

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considering in addition to informing you about investment risk we hear beta is a

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whiz at the limbo [beta symbol performing limbo]

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