Institute of Chartered Financial Analysts of India (ICFAI) University 2006 Certification Finance Security Analysis – II - Question Paper

Caselet 3

learn the caselet carefully and ans the subsequent questions:

11. A value of beta explains the risk associated with a security. With respect to this discuss different kinds of beta values.

(5 marks) < ans >

12. Beta is a good tool for assessing the movement of stock based on the relationship ranging from the return on the stock and the market. But there are a few issues where only beta is used for determining risk of an investment. explain.

(7 marks) < ans >

13. The Beta of a security fails to correctly reflect the inherent risk during the period of economic slowdown and recession. discuss.

(6 marks) < ans >

In the latest market run, there has been a high level of price volatility. If 1 has to watch out for the movement of the stock of the leading scrip then the most common way to measure this is by means of ‘beta’. Beta is a measure that tells about how much a stock has moved in relation to the index for a described period of time. Beta value can be readily available from the different websites. Ideally the stock should be such, which can always beat the index. It should rise more when the market are bullish and falls less when market is in a bearish grip. So according to the risk taking ability of the individual, the stock should be opted. A proper strategy should be framed to invest in a portfolio based on the stock’s sensitivity to the market index. Investments that carry higher than avg. risks should offer the opportunity to earn much higher returns, but in reality, however, it is not very easy to strategic investments, which adhere to that principle. There are many variables that affect the stock return; moreover there is more than 1 way of calculating risk, thus making risk-reward assessment a complex exercise. Mostly all variables are based on past data and can give little clue about future.

An analysis of past beta across sectors does not give enough evidence to suggest, that high beta stocks deliver better returns in rising market, or fall more steeply in falling market. This is primarily because beta values change rapidly based on market moods. Beta values are useful for positioning a portfolio based on your risk appetite and buying a stock based on beta alone is not a good idea. Investors can obtain the best use of the beta ratio in short-term decision-making, where price volatility is important. If you are planning to buy and sell within a short period, beta is a good measure of risk. However, as a single predictor in long-term investment, the beta has too many flaws. Careful consideration of a company’s fundamentals will provide you a much better picture of the potential long-term risk. Beta is also useful in reducing the combined systematic risk of the portfolio. If an investor has a portfolio of highly volatile stock which had beta greater than one during the past 1 year, then it make sense to decrease overall portfolio risk by adding defensive stocks having beta less than 1.

Earning:   Approval pending.