Why is beta of asset=unlevered beta?

Delilah12's picture
Rank: Orangutan | 282

Didn't get this-

Beta Equity = Beta Asset + (D/E)*(Beta Asset- Beta Debt)

Beta Asset is not dependent on how the assets of a firm are financed and hence it is equivalent to a firm's unlevered beta. T being the tax rate, the relationship between the levered and unlevered beta can be written as

Beta Levered = Beta Unlevered * (1+{(D/E)(1-T)}) - {Beta Debt * [(D/E)(1-T)]}

Comments (4)

Best Response
Sep 17, 2017

unlevered beta (asset beta)
levered betta (equity beta)

1) Now let's look at the similarity: they are both measures of volatility.

2) Now let's look at the difference: levered beta takes into account the company's debt, whereas unlevered beta does not consider the debt held by the firm.

3) What does this imply? The volatility of a company without any leverage is the result of only its assets. Therefore, asset beta measures the risk of the business itself while equity beta measures the risk of a share in the firm. Asset beta is the inherent systematic risk of the company's operations.

4) But you may ask why? Or in more concrete terms why is "business risk" meaning business operations' risk not incorporate debt into the calculation? Well, first you need to distinguish between "business risk" and "financial risk."

Financial risk is a company's capital structure, in other words, how much debt they have, or how leveraged they are. So, a company with debt has a higher risk than a company with no debt because they have to divert some of their cash flows to paying the interest and eventually paying off the principal of the debt.

The reason why asset beta is unlevered beta is that the operations within a business do not get riskier with more debt. Well, in general sense it does get riskier, but I think in the context of the term "beta" it doesn't get riskier.

    • 3
Sep 17, 2017

Excellent explanation, got it in one go. Thanks!

Oct 25, 2018

I found this very useful, thank you!!

Oct 25, 2018