How is a company's beta calculated?

The correct answer is based on the concept of beta, which measures a company's stock volatility in relation to the broader market. Beta is calculated by taking the covariance of the return on the company’s stock with the return on the market and dividing that by the variance of the return on the market.

This calculation helps investors understand the risk associated with the company's stock relative to market movements. A beta greater than 1 indicates that the stock is more volatile than the market, meaning it tends to rise more during market upswings and fall more during downswings. Conversely, a beta less than 1 suggests that the stock is less volatile than the market.

The other options do not accurately describe how beta is calculated. For instance, calculating market return divided by company return does not reflect the relationship between the two necessary variables for determining beta. Similarly, while the average covariance might seem relevant, beta specifically needs the variance of the market return in its denominator to assess relative volatility correctly. The choice involving the company’s net income and total equity pertains to financial ratios such as return on equity, which do not relate to the volatility measured by beta.