Is Positive Beta Better than Negative Beta?, response (500 words)

OriginalQuestion:

Is Positive Beta Better than Negative Beta?

A Beta factor represents risk in a financialinstrument or commodity. Explain the reasons for changes in beta and explain ifone should be more concerned with a negative versus positive factor. Be sure toreference volatility. Please provide an example of negative Beta.

StudentNumber #1 Response:

Beta is the measure of volatility or systematic riskof a security as compared to the whole market (Bates, Kidwell, Parrino, 2015).It is often used to calculate expected returns and beta that is less than 1 isless likely to be volatile while a beta over 1 will be more volatile than themarket. An investor should be concerned with negative and positive factors ofsecurities because this will determine how someone chooses to invest. A stockwith a positive beta that is greater than one may be more volatile with higherrisk but also offer higher returns, examples would be something like techstocks as opposed to utilities stocks which usually have a beta of less thanone and offer more stability but a lower rate of return.

A good example of negative beta would be bonds in aportfolio which has the characteristics of negative beta because it usuallymoves opposite of the market (Caplinger, 2012). By having bonds which providenegative beta in a portfolio like a 401k it kind of offers some protectionagainst positive beta which because of their volatility can make and lose a lotof value. The bonds with negative beta can act as a counter balance insuringthat even though there will not be a high return rate there will also not behuge losses.

References:

Bates, T. Kidwell, D. Parrino, R. (2015). Fundamentalsof Corporate Finance. 3rd Edition. Retrieved 04/27/2016

Caplinger, D. (2012). Negative beta stocks: Worthbuying? Retrieved 04/27/2016 from

http://www.fool.com/investing/beginning/2012/12/12/negative-beta-stocks-worth-buying.aspx

StudentNumber #2 Response:

Anyone who plays the stocks has a firm understandingof beta. One can look at the beta of a stock to get a better understanding ofhow the stock reacts to the market. According to investopedia.com, “Betais calculated using regression analysis, and you can think of beta as thetendency of a security’s returns to respond to swings in the market. A beta of1 indicates that the security’s price will move with the market. A beta of lessthan 1 means that the security will be less volatile than the market. A beta ofgreater than 1 indicates that the security’s price will be more volatile thanthe market. For example, if a stock’s beta is 1.2, it’s theoretically 20% morevolatile than the market” (2015).

While a beta factor represents a risk, there is such a thing as a negativebeta. According to blogspot.com, “By that definition, any investment thatwhen added to a portfolio, makes the overall risk of the portfolio go down, hasa negative beta. A more intuitive way of thinking about this is that a negativebeta investment represents insurance against some macro economic risk thataffects the rest of your portfolio adversely. A standard example that isoffered for a negative beta investment is gold, which acts as a hedge againsthigher inflation (which devastates financial investments such as stocks andbonds). It is also true that puts on stocks and selling forward contractsagainst indices will have negative betas” (2009). When there is a negativebeta, this means that the overall rate on return of the investment has beenreduced. In the example of gold, the rate of return on the investment of goldis typically low, thus, making it a potentially poor investment.

Reference:

http://www.investopedia.com/terms/b/beta.asp

http://aswathdamodaran.blogspot.com/2009/02/can-betas-be-negative-and-other-well.html

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