Beta is the measure of volatility risk, also known as systematic risk, of a share on the stock market. As such, the measure of Beta can be levered to take into consideration the debt risks associated with a company, commonly called the Equity Beta, or unlevered to remove debt considerations and isolate the risk volatility associated only with a company’s assets, commonly referred to Asset Beta.
Equity Beta is the debt levered measure of volatility of a share that has been calculated to include debt to equity risk considerations for a company, such as the capital structure of the company being assessed.
Calculating the unlevered Beta removes the debt consideration from the Beta and isolates the risk of a share due solely to company assets. Thus, the unlevered Beta is often referred to the Asset Beta.
The Beta can be levered or unlevered using the Debt to Equity ratio and the tax rate, as depicted in the formula above. The variables required for the beta levered formula are listed in more detail below.
Also known as the Asset Beta. This is the Beta value that solely considers the systematic risk of assets held by a company or organisation.
The Debt to Equity ratio is calculated by equating the total value of debt held by a company and then dividing it by the total value of equity held by the company. The Debt to Equity ratio is a common accounting ratio.
The Tax Rate is the percentage rate of tax required to be paid by a company annually. This rate is set by the government of the country in which the company operates.
Also known as the Equity Beta or just “Beta”. This rate takes into consideration the capital structure of a company and the annual tax rate it must pay on its earnings.
In order to calculate the levered beta, the values for unlevered beta and the debt to equity ratio must be obtained, as well as the tax rate. A Beta value of 1 generally indicates that the risk of the shares or portfolio being evaluated is equal to the market risk. A beta higher than 1 indicates that the shares carry more risk than the market risk, and a beta lower than 1 indicates that the share’s risk is lower than the market risk.
For example, to calculate the levered beta for a share or portfolio that has an unlevered beta (βU) of 1.33, a debt to equity ratio (D/E) of 13% and a company tax rate (TC) of 35%, the formula would be as follows:
βL = βU * (1+((1 - Tc) * (D/E)))
βL = 1.33 * (1+((1 - 0.35) * 0.13))
βL = 1.45
In this example, based on the values given, the Beta Levered equates to 1.45. This new levered beta denotes that the volatility of the shares being valued is higher than the market risk, inclusive of the firm’s capital structure, and should be considered with caution.
A strong advantage of levered and unlevered beta calculations is the insight gained from each the asset and equity beta. Calculation of the asset beta gives a better indication of performance of a company, based on its assets, in relation to the market risk the company operates in. The equity beta takes into consideration capital structure in relation to financing decisions made by that company, giving an insight to how well the company may perform based on how much of its operations are financed with debt or equity and taking into consideration the tax benefits of debt.
The unlevered beta, commonly referred to as the asset beta, can be used when evaluating market volatility of a company in regard to how well its assets perform. The levered beta, commonly referred to as the equity beta, gives a picture of well a company performs against market volatility based on its financing decisions and capital structure. If a security's unlevered beta is positive, investors want to invest in it during bull markets. If a security's unlevered beta is negative, investors want to invest in it during bear markets.
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