Risk Return MeasuresEquity
There are measurements of risk and return for equity shares. These measurements typically have an interchangeable benchmark. There are two common measurements used to rate return and risk relative to a standard. These measurements are Alpha and Beta.
Beta is the measure of risk relative to a benchmark, typically assumed to be the domestic exchange or the market of the investment. In this case, “risk” is measured by the volatility of investment relative to the benchmark itself. During a selected time period, if the benchmark moves two percent upwards, and the comparison investment moves upwards two percent, they are equal in their volatility for that time period. The volatility of the investment is 100 percent of the benchmark’s volatility, so the beta is stated as one. If the benchmark moves up two percent and the investment moves up four percent, the volatility of the investment is 200 percent of the benchmark, and the beta is written as two. If the benchmark moves upward two percent and the investment moves upward one percent, the volatility is half, or 50% of the yardstick. The beta is marked in decimal as 0.5. Lastly, if the benchmark moves upwards two percent and the benchmark moves down four percent, the volatility is negative by 200%. Since the investment incurred negative returns in comparison to the benchmark, it’s written as a negative. The beta is written as -2.
A benchmark’s selection is important, and should always be logically correlated to the investment being measured. The Domestic exchange, domestic economy, domestic market, or industry is preferred. The vast majority of the time, the investment’s selected beta is the asset’s traded exchange.
While beta is the measure of volatility, taken as risk, of an investment relative to a benchmark, Alpha is relative return. The benchmark’s return is the baseline. The alpha of the investment, for each percentage point over or under the return of the baseline, is plus or minus one. If the benchmark returned 10 percent, and the comparison investment returned 12%, the alpha is positive two. If the comparison investment returned 6%, the alpha is negative four. If the alpha and the benchmark were equal, the alpha is zero. If the Alpha’s benchmark is set to the market, a positive alpha indicates strong previous returns.
In certain investment classes, especially funds which require investment management, alpha can be related to the skill of the investment manager. Performance higher than the benchmark is shows the ability of managers to generate returns higher than the benchmark. If ability to earn a return is assumed as related to manager’s skills, alpha can be an indicator of investment skill. Investment skills that are required for generating return are plentiful. Economic prowess, analytical prowess, risk management, portfolio management, and informational management are all essential to being successful in business and investing. Information management does not necessarily derive from being able to access information. If an acquisition oriented network is properly established information is excessively plentiful and easily retrieved in the digital age. Information management aptitude is primarily determined by the ability to retrieve, analyze and apply quality information to a preset business or investment strategy. There is no realistic advantage in accessing information in the digital age unless engaged in insider trading, which is illegal.
Beta Alpha Combinations
Beta and Alpha are relevant to each other if they are both based on the same benchmark, allowing investors to receive risk and return relevant to the same source. An investor reading the alpha and beta given by statistical analysis should ensure both have been compared to the same benchmark.
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