Financial modelling terms explained

Alpha

Alpha is an investment return measure that shows the performance of a portfolio compared to a benchmark. The benchmark is usually an index or a market portfolio.

What is Alpha?

Alpha is a measure of how well an investment or a portfolio of investments has performed in comparison to a benchmark or to an investment style. It is calculated as the difference between the rate of return of the investment or portfolio and the rate of return of the benchmark or investment style. Alpha is expressed as a percentage or as a decimal. A positive alpha means that the investment or portfolio has outperformed the benchmark or investment style, while a negative alpha means that the investment or portfolio has underperformed the benchmark or investment style.

What Does Alpha Measure?

Alpha measures the difference between a portfolio's actual return and the return that would be expected, given the portfolio's risk. It is used as a measure of a portfolio's risk-adjusted performance.

How Do You Calculate Alpha?

Alpha is a measure of a fund manager's skill or performance. It is calculated as the difference between a fund's return and the return of a benchmark index, such as the S&P 500. Alpha is expressed as a percentage or a number of basis points. A positive alpha means the fund has outperformed the benchmark, while a negative alpha means the fund has underperformed the benchmark.

What's the Difference Between Alpha and Beta?

Alpha is a measure of a portfolio's performance on a risk-adjusted basis. It is calculated by subtracting the risk-free rate from the portfolio's return, and dividing the result by the portfolio's standard deviation.

Beta is a measure of how much a particular security or portfolio moves in relation to the market. A beta of 1 indicates that the security or portfolio moves in line with the market. A beta of less than 1 means the security or portfolio is less volatile than the market, and a beta of greater than 1 means the security or portfolio is more volatile than the market.

How Do You Calculate Beta?

There are a few ways to calculate beta, but the most common is the capital asset pricing model (CAPM). In order to use CAPM to calculate beta, you need to know a few things: the risk-free rate, the market premium, and the beta of the individual stock.

The risk-free rate is the return you can expect to receive on a risk-free investment, like a government bond. The market premium is the amount of extra return you can expect to earn by investing in the stock market instead of a risk-free investment. And finally, the beta of the stock is the measure of how much a stock's price moves in relation to the overall market.

To calculate beta, you first need to find the stock's historical returns. You can do this by looking at a financial website or by downloading historical stock prices from a financial data provider. Once you have the historical returns, you can calculate the standard deviation of those returns. The standard deviation is a measure of how much a stock's returns vary from the average.

Next, you need to find the historical returns for the market. Again, you can find this information on a financial website or by downloading historical market data. Once you have the market returns, you can calculate the standard deviation of those returns.

Finally, you can use the following equation to calculate the beta of the stock:

beta = standard deviation of stock returns / standard deviation of market returns

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