BUS202: Principles of Finance

TERM

• beta

   In finance, the Beta (β) of a stock or portfolio is a number describing the correlated volatility of an asset in relation to the volatility of the benchmark that said asset is being compared to.

The words stock and equity are used interchangeably, because a stock is reflective of a piece of ownership in a company. In general, investors buy stocks for two reasons: because they expect the company to grow its product and market share over time (growth) or because they feel that the company is undervalued based on its current stock price. Analysts may research a stock from a fundamental or a technical lens.

Fundamental analysis involves analyzing a company's financial statements and health, its management and competitive advantages, and its competitors and markets . Technical analysts study the patterns and price fluctuations and attempt to forecastthe direction of prices through the study of past market data, primarily price, and volume. A stock's price is essentially determined by the buying and selling decisions of fundamental and technical analysts, who often manage large sums of money and have access to broad pools of data. Some stocks tend to fluctuate more than others on a day-to-day basis, and the metric called Beta describe's the variance of a stocks day to day price. Stocks that tend to experience larger swings have higher beta values and expose owners to more specific risk.

In order for a company to be publicly traded on an exchange, it must comply with the regulations of that exchange board (NYSE or NASDAQ). Public investors are entitled to complete, accurate, and timely financial information about their investments. Companies generally announce updated financial figures on a quarterly basis. These figures include their current revenues, expenses and profits, and investors use this information to assess the company's financial health. For most established companies, these reports are consistent and predictable and barely affect a stock's price. Macy's may announce higher profits in quarter 4 than quarter 3, but its price might not move, because analysts expected that Christmas would bring additional sales based on past data.

When a company announces its earnings as higher or lower than expected, the stock may experience a sudden shift in value. A higher than expected profit may come from increased revenues or decreased expenses. If a growing company announces higher than expected profits because of decreased expenses, it signals to investors that the company has found a cheaper way to produce its good. That could in turn affect theexpected returns of a competitor's stock, either positively or negatively, depending on how analysts forecast the effect. The announcement of higher than expected sales from Ford could affect its stock price significantly, and it could set into motion a chain of events. If analysts believe that the trend is based on a shift away from public transportation, it could raise the price of GM, Toyota, and maybe even Chevron. If Nvidia, a company who produces micro-processors for smart phones, announces higher than expected profits on reduced production costs, it might not only cause their stock to spike, but it could lead to a decrease in the price of the stock of their primary competition, Intel.

In general, fluctuations in one stock will often lead to fluctuations in another stock. There are times when the markets are relatively stable and those when it is relatively volatile. Consider the image below. The correlation of 0.769 suggests that the volatility of the stock market in one month is very highly correlated to that in the previous month.