1) Calculate the cost of capital and make investment decisions (only invest in projects with a return rate higher than the cost of capital);
2) Calculate the capital cost and formulate performance appraisal and incentive standards;
3) Calculate the cost of capital and evaluate assets (beta is the basis of discounted cash flow model);
4) Determine the systemic risk of a single asset or portfolio for portfolio investment management, especially the hedging (or speculation) of stock index futures or other financial derivatives.
The discussion about the fourth use of Beta will be the focus of this article.
Combination β
The beta coefficient has a very good linear property, that is, the beta of an asset portfolio is equal to the weighted sum of the beta coefficients of a single asset according to its weight in the portfolio.
5) The application of beta coefficient in the securities market.
Beta coefficient reflects the sensitivity of individual stocks to market (or broader market) changes, that is, the correlation between individual stocks and broader market or "stock" in popular parlance. Securities with different beta coefficients can be selected according to the market trend forecast to obtain additional income, which is especially suitable for band operation. When a big bull market or a non-rising stage of the market is predicted with confidence, you should choose those securities with high beta coefficient, which will multiply the market yield and bring you high returns; On the contrary, when a bear market comes or a certain decline stage of the market comes, you should adjust your investment structure and choose those securities with low beta coefficient to resist market risks and avoid losses.
In order to avoid unsystematic risks, we can choose those securities with the same or similar beta coefficient for portfolio under the corresponding market trend. For example, the beta coefficient of a stock is 1.3, which means that when the market rises 1%, it may rise 1.3%, and vice versa; But if the beta coefficient of a stock is-1.3%, it means that when the market rises 1%, it may fall 1.3%. Similarly, if the market falls by 1%, it may rise by 1.3%.