Overview of Beta Returns
Regression Line for Alpha
Risk Profile for Beta Return Portfolios
A risk profile is an analytical evaluation of an investor's acceptance of risk. It is used to develop a portfolio with the best balance between risk and return, as not all investors have the same reactions to risk. The risk profile will match the investing style with the level and type of risk the investor is willing to tolerate. Alpha and beta risk can be looked at differently if they are taken as historical measures that are related to each other. Alpha is the historical deviation of the return of an asset and the expected return, and beta is the historical move of the asset away from the benchmark point. If an investor has stock, the beta is the risk that the stock's value will change compared to the overall market. The alpha tells the investor how well the investment manager is doing compared to the market benchmark.Cash, fixed interest, property and international shares are all different investment options that have varying levels of risk associated with them. Cash, fixed interest and property are less risky investments than international shares due to many risks such as geo-political and tax that may be specific to a country. Thus, when there is low risk, the return may not be as high. With greater risk comes greater return, but the risk must be a calculated risk to achieve expected returns.
For example, if Mary purchased shares in Big Systems Inc. at an above market price, and the shares then experience a rapid dip in price, Mary will not want to sell until the price increases so that there will not be any share, or profit loss. If she cannot tolerate loss, the stock will not be sold and will have a negative impact on Mary’s total portfolio meaning that any profit made with other equity or debt will be impacted due to the above price purchase of Big Systems Inc. stock. If she needs to make money, then alpha risk must account for volatility in order for the stock to make more money than can be gained by normal market movement. In this situation, the risk of low return is part of Mary’s risk profile.
Retirement investments are usually not within the same category due to age and need. This means that retirees are less inclined to take risks and are in greater need of liquid assets to assure they have enough cash, or cash equivalents, on hand to meet their needs. Thus, Mary’s needs will be different and when considering the concepts of alpha and beta risk age, need, and overall cash and investment needs must be considered to meet specific return criteria while always keeping in mind the risk factors and how varied risks can negatively impact returns.
Beta Return Calculations
Covariance is the measure of how two assets move together. Correlation is the correspondence of movement between one variable and another, showing that there is a link between the two. A positive correlation is a relationship between two variables in which one increases when the other increases. A negative correlation is a relationship between two variables in which one increases when the other decreases.Like the variance, the covariance for multiple comparisons becomes a standard deviation. Using standard deviations, the beta formula changes.