Investment Strategies

Discussion Question 2

There are many methods an investor can use to determine if a stock is a good buy or not . Three indicators often used to assess the risk of a security are beta , alpha and the Sharpe ratio

One of the most popular measures of risk associated with a security is its beta . Beta is a measure of a stock 's volatility in relation to the market as a whole . The market is given a beta of 1 .0 and individual stocks are ranked according to how much they deviate from

the market 's beta . Stocks with a beta of less than 1 .0 are considered less volatile than the market and , therefore , pose less risk . Stocks that have betas higher than 1 .0 are considered more volatile than the market and therefore , pose more risk . All things being equal , an investor would expect to see higher returns on a stock with a beta higher than the market than one with a beta lower than the market (1

Beta is also a key component for the capital asset pricing model (CAPM The original CAPM defined risk in terms of volatility , as measured by a stock 's beta coefficient . The formula is : Kc Rf beta Km - Rf where

Kc is the risk-adjusted discount rate (also known as the cost of capital

Rf is the rate of a risk free ' investment , i .e . ten-year treasury bill

Km is the return rate of a market benchmark , such as the S P...