A measure that stands out, and the most important one for our purposes, is beta. Beta is simply the slope (i.e., the change in the excess return on the stock over the change in excess return on the market portfolio) of the characteristic line. If the slope is 1.0, it means that excess returns for the stock vary proportionally with excess returns for the market portfolio.

In other words, the stock has the same systematic risk as the market as a whole. If the market goes up and provides an excess return of 5 percent for a month, we would expect, on average, the stock's excess return to be 5 percent as well. A slope steeper than 1.0 means that the stock's excess return varies more than proportionally with the excess return of the market portfolio. Put another way, it has more unavoidable risk than the market as a whole. This tlpe of stock is often called an "aggressive" investment. A slope less than 1.0 means that the stock's excess return varies iess than proportionally with the excess return of the market portfolio. This type of stock is often called a "defensive" investment. Examples of the three tlpes of relationship are shown.

The greater the slope ofthe characteristic line for a stock, as depicted by its beta, the greater its systematic risk. This means that, for both upward and downward movements in market excess returns, movements in excess returns for the individual stock are greater or less depending on its beta. With the beta of the market portfolio equal to 1.0 by definition, beta is thus an index of a stock's systematic or unavoidable risk relative to that of the market portfolio. This risk cannot be diversified away by investing in more stocks, because it depends on such things as changes in the economy and in the political atmosphere, which affect all stocks.

In addition, a portfolio's beta is simply a weighted average of the individual stock betas in the portfolio, with the weights being the proportion of total portfolio market value represented by each stock. Thus the beta of a stock represents its contribution to the risk of a highly diversified portfolio of stocks.