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Let’s move on to beta. Do you remember a few slides back when I talked about a security’s systematic risk—the market risk that can’t be diversified away? Well, that’s beta. A security’s beta measures the percentage of its price movements that are caused by movements in the overall market. In other words, beta tells us how a movement in the market can be expected to impact a security’s price.

For fixed income securities, the market is defined as the benchmark T-bill; for stocks, it's the S&P 500 index. A beta of 1 means a security's price will move in tandem with the market: If the market goes up by 5%, the security's price also rises by 5%. A beta of less than 1 means a security will be less volatile than the market, and a beta more than 1 tells you a security will be more volatile than the market. So the rule is, the higher the beta, the greater the risk of being affected by market swings.

One thing that’s important to keep in mind about beta is that a low beta doesn’t necessarily translate into lower volatility. While a low-beta stock may not be as affected by market movements as stocks with higher betas, that doesn’t mean other non-market factors won’t cause its share price to fluctuate wildly. For example, a utility with a low beta may experience significant volatility due to rising energy costs or changes in its regulatory environment.