Finance

QUESTION: How may beta coefficient be used to standardize returns for risks to permit comparisons of mutual funds.

Mutual funds are a diversified investment product that makes it possible for investors to own a portion of a larger portfolio of shares managed by a professional manager. Mutual funds offer small investors opportunity to own a portion of a professionally managed diversified portfolio which would have been difficult to create or own with a small amount of capital. Beta is a variable which shows the relationship between the rate of return and the market premium rate. The beta value is the slope of the line when this relation is graphed. The procedure to find beta is the same as finding the slope of a line. Beta can be calculated when the following variables are known: required rate of return, the risk-free rate and the market premium rate.

When calculating for the beta-coefficient of mutual funds, investors use statistical regression analysis to calculate the beta coefficient or beta of a mutual fund portfolio. Investors use beta as a measure of risk and volatility. Investors also use the beta coefficient as a performance measure, comparing the mutual fund’s performance against the performance of other securities.

Investors typically give the stock market as a whole a beta value of one. Investors calculate beta values for a mutual fund by examining the fund’s historic price movements over a period, usually three to five years. The beta value of the mutual fund portfolio is either less than or greater than one. Mutual fund portfolios with a beta value greater than one means that it has the potential to earn higher returns than the overall stock market. A value greater than one also means the fund possesses a potentially higher investment risk. A mutual fund with a beta value of less than one means that it has the potential to earn lower returns than the overall stock market, but can also mean that it possesses a lower investment risk.

A beta value...