What is the fundamental equation used to calculate beta?

The fundamental equation used to calculate beta is based on the concept of covariance, which measures how the returns of an asset move in relation to the market returns. Beta specifically quantifies this relationship by assessing the covariance of the asset's returns with the returns of the market, and then normalizing it by the variance of the market returns.

In this context, beta is expressed mathematically as:

Beta = Covariance (Asset Returns, Market Returns) / Variance (Market Returns)

This formula indicates that beta is not just a simple ratio of returns or standard deviations, but rather a more nuanced indicator that reflects the sensitivity of an asset's returns to the market's movements. By focusing on covariance and variance, it allows investors to understand how much the asset's returns are expected to change in response to fluctuations in the market as a whole. This is critical for risk assessment and investment decisions.

Other options presented do not correctly define beta:

• The first choice refers to variance of returns and does not incorporate the concept of covariance, which is essential for the beta calculation.

• The third option suggests a simple ratio of average returns, which ignores the volatility and relationship of movements between the asset and the market.

• The last choice mentions the standard deviations, which, while