What is the difference between alpha and beta?

Answer:

Alpha is used in Finance as a measure of performance. Alpha is often considered to be the active return on investment measures investment performance against a market index or benchmark which is the movement of the market as a whole. Excess investment returns relative to the benchmark index of investment alpha.

Beta is a measure of the volatility, or systematic risk of a security or a portfolio compared to the market as a whole. Beta is used in the pricing model of capital assets (CAPM), which calculates the expected return of an asset based on its beta and expected return of the market. Beta also known as beta coefficient.

Alpha and beta are used in conjunction with the investment managers to calculate, compare and analyze returns. They are two of the five standard calculation of technical risk as the standard deviation, R-squared and the Sharpe ratio.

Alpha

Alpha is perceived as assessing the performance of the portfolio Manager. Alpha is used for mutual funds and for all investment types. It is often represented as a single number (e.g. 3 or -5), but this refers to the percentage of measurements, such as portfolio or Fund performed compared to the reference index (i.e., 3% more or 5% worse).

In short, an alpha of 1.0 means that the mutual Fund or investment has exceeded 1 percent. On the contrary, the alpha of -1.0 means that the mutual Fund or of the investment below its benchmark index by 1%.

Alpha Examples

For example, 8% of the profitability of the mutual Fund is impressive, when the equity markets in General return is 4%, but it is much less impressive, when the broader market earns 15%. “Alpha” takes into account the efficiency of the overall market, to give investors a more accurate picture of the effectiveness of investments.

If the model of capital asset pricing (CAPM) analysis shows that a portfolio has to be earned 5% (based on risk, economic conditions and other factors), but instead earned only 3%, alpha of the portfolio is -2%. In the CAPM, alpha is the rate of return that exceeds what the model predicted. Investors usually prefer investments with high alpha.

The formula for alpha:

Comparing the investment performance of the benchmark, we can determine how the portfolio Manager added to return the investment. In short, alpha is the return on investment is not the result of General market movements.

The portfolio managers seek to generate alpha in a diversified portfolio diversification is designed to eliminate unsystematic risk. Because alpha represents the behavior of the portfolio relative to the benchmark, it is of value that a portfolio Manager adds or subtracts from the refund. As such, an alpha of zero would mean that the portfolio or Fund perfectly tracking with the benchmark, and the Manager are not added or lost any value.

Let’s examine in greater detail. To read more in-depth look at the alpha.

Beta

Beta is a measure used in fundamental analysis to determine the volatility or portfolio of assets relative to the market as a whole. Beta is often used as the risk-reward measure meaning it helps investors determine how much risk they are willing to take to achieve in exchange for the assumption of risk. The variability of stock prices should be considered in the risk assessment. If you believe that risk as the possibility of a stock losing its value, beta of appeal as a proxy for risk.

Reference number for alpha zero (investment followed exactly with market expectations), but the base amount of beta-one. Beta is one indication that the price moves exactly as the market moves.

A beta less than 1 means the security will be less volatile than the market.

Beta greater than 1 means that the security and the price will be more volatile than the market. If the stock beta is 1.5, it was determined to be 50% more volatile than the overall market.

Beta Examples

Here are the beta version (at the time of this writing) for three popular stocks:

Micron technology Inc (MU): beta = 1.756
The Coca-Cola company (Ko): beta = .564
Apple (aapl),: beta = 1.114

We see that micron is considered to be 75% more volatile than the market, while Coca-Cola is almost 50% less volatile than the market, and Apple more in line with the market or about 10% more volatile than the market.

Beta to vary between companies and industries. Many utilities stocks, for example, a beta less than 1. Conversely, most high-tech, Nasdaq-based stocks with beta greater than 1, that enables a higher rate of return, but also creates more risk.

If a positive alpha is always more desirable than negative, beta, on the other hand, is not so straightforward. Some investors are risk averse and prefer to have less risk in your portfolio or beta, i.e. retirees seeking steady income. Other, more risk-tolerant investors looking for growth and willing to invest in stocks with a high beta with the aim of achieving higher returns due to higher volatility.

It is important that investors distinguish between short-term risks; where beta and price volatility are useful; and long-term risks, where the fundamental (big picture) risk factors are more common.

Looking for investors with low risk may gravitate toward low-beta stocks, which means that their prices will not fall as much as the overall market during the recession. However, those same stocks will not rise as much as the market as a whole during lifting. By calculating and comparing the coefficients of beta, investors can determine their optimal risk-reward ratio for your portfolio.

The Formula For The Beta

Although most investment sites like Investopedia.com beta is calculated for you, below is the formula for calculating beta:

  • Covariance measures how two stocks move together. A positive covariance means that stocks tend to move together, when their price will go up or down. A negative covariance means that stocks are moving opposite each other.
  • Dispersion, on the other hand, refers to how far a stock moves relative to its mean value. For example, the variance is used to measure the volatility of the individual stocks over time. Covariance is a measure of the correlation of the price movements of two different stocks.

Read more about the beta, including calculations and interpretations, please, what is the formula to calculate beta? and beta: Gauging price fluctuations.

Past Performance

How alpha and beta are retarded in the ratio of risk and it is important to remember that past performance is no guarantee of future results.

Investors can use alpha to measure the performance of the portfolio Manager with the standard, and also to control the risk or beta associated with investments that comprise the portfolio. Some investors can search either the beta or high beta to low, depending on their risk tolerance and expected rates of return.

More details about these major investment activities, please read the alpha and beta for beginners.

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