If you plotted the returns of a particular stock versus those in the S&P 500 Ind

Question

If you plotted the returns of a particular stock versus those in the S&P 500 Index over the past 5 years, what would the slope of the regression line tell you about the stock’s market risk? If you plotted the returns of a particular stock versus those in the S&P 500 Index over the past 5 years, what would the slope of the regression line tell you about the stock’s market risk? If you plotted the returns of a particular stock versus those in the S&P 500 Index over the past 5 years, what would the slope of the regression line tell you about the stock’s market risk?

Explanation / Answer

If one were to plot the returns of a particular stock versus the index (namely S&P 500), then on computing the slope one would be able to arrive at the Beta. Beta is a measure of risk against a benchmark. In this case we will be able to arrive at the Beta of the stock vs. the market over a 5 year horizon (long term).

Beta would indicate the relative risk of investing in the stock against investing in the market. The interpretation for the value so generated is as follows - (Market Beta is always 1)

Beta of stock (based on calculation of Slope) = 1 --> Stock moves in tandem with market (if market falls / rises by $1, the stock would also fall / rise by $1)

Beta of stock (based on calculation of Slope) > 1 --> Stock is riskier than market (the fall / rise in the stock is going to be steeper than that of the market)

Beta of stock (based on calculation of Slope) < 1 --> Stock is less risky than market (the fall / rise in the stock is going to be milder than that of the market)

Further, if Beta is positive, then the stock is positively correlated with the market; if Beta is negative, then the stock is negatively correlated to the market.

Another formula in excel which will return the Beta for the stock is "Intercept". The same results will be derived by using Slope and intercept formula.

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