Finance Question-Asset Beta----mods don't move! (yet)
Discussion
Mods can you leave this here for a short while as the finance forum doesn't get a lot of traffic please?
My question is to do with Asset beta and its definition. Asset beta is defined as 'the change in return on a portfolio of all the firm's securities (debt and equity) for each additional 1% change in the market return.'
Yet asset beta is also referred to as unlevered beta, i.e. the beta of a company that doesn't have any debt, so in the words of investopedia it 'removes the financial effects from leverage'.
These three definitions seem to contradict each other-how can you have debt and not have debt, or leverage without taking on debt??
My question is to do with Asset beta and its definition. Asset beta is defined as 'the change in return on a portfolio of all the firm's securities (debt and equity) for each additional 1% change in the market return.'
Yet asset beta is also referred to as unlevered beta, i.e. the beta of a company that doesn't have any debt, so in the words of investopedia it 'removes the financial effects from leverage'.
These three definitions seem to contradict each other-how can you have debt and not have debt, or leverage without taking on debt??
krisdelta said:
I may be wrong, are these not simply "what if" models - giving you a broad spectrum of outcomes based on an incremental data point changing? If so, the outcome will be based on the situation it's being applied to. E.g. Debt / Non-debt etc.
Not sure what you mean? They are 'what if' models that are trying to allow for risk but my problem is the Asset beta seems to include debt but exclude it at the same time-tax allowance is excluded but D/E ratios and a beta for debt are still included. Why would we have to allow for the company's sensitivity to debt?Easier to think about in terms of how an asset beta is different to equity beta.
Equity beta = how volatile a given stock's price movements tend to be relative to the overall market's movements. Takes into account the company's capital structure (so if a company loads up on debt you will see that it tends to be more volatile than it would otherwise be as it trades in the stock market). This is hence a levered beta.
Asset beta = how volatile the underlying business is, irrespective of capital structure, as it is not affected by how the capital employed has been funded. You calculate asset beta by stripping out the capital structure impacts on the equity beta. Hence it is "unlevered" as it is the same irrespective of the actual amount of leverage. The answer to the conundrum you refer to exists when a company has zero leverage hence its equity beta equals its asset beta.
Equity beta = how volatile a given stock's price movements tend to be relative to the overall market's movements. Takes into account the company's capital structure (so if a company loads up on debt you will see that it tends to be more volatile than it would otherwise be as it trades in the stock market). This is hence a levered beta.
Asset beta = how volatile the underlying business is, irrespective of capital structure, as it is not affected by how the capital employed has been funded. You calculate asset beta by stripping out the capital structure impacts on the equity beta. Hence it is "unlevered" as it is the same irrespective of the actual amount of leverage. The answer to the conundrum you refer to exists when a company has zero leverage hence its equity beta equals its asset beta.
sm1tty said:
Easier to think about in terms of how an asset beta is different to equity beta.
Equity beta = how volatile a given stock's price movements tend to be relative to the overall market's movements. Takes into account the company's capital structure (so if a company loads up on debt you will see that it tends to be more volatile than it would otherwise be as it trades in the stock market). This is hence a levered beta.
Asset beta = how volatile the underlying business is, irrespective of capital structure, as it is not affected by how the capital employed has been funded. You calculate asset beta by stripping out the capital structure impacts on the equity beta. Hence it is "unlevered" as it is the same irrespective of the actual amount of leverage. The answer to the conundrum you refer to exists when a company has zero leverage hence its equity beta equals its asset beta.
Thanks for the reply. I'll have another read of the passage in the chapter and see if that fits in with their definition and formula; I think I am getting confused because the formula has a beta for debt.Equity beta = how volatile a given stock's price movements tend to be relative to the overall market's movements. Takes into account the company's capital structure (so if a company loads up on debt you will see that it tends to be more volatile than it would otherwise be as it trades in the stock market). This is hence a levered beta.
Asset beta = how volatile the underlying business is, irrespective of capital structure, as it is not affected by how the capital employed has been funded. You calculate asset beta by stripping out the capital structure impacts on the equity beta. Hence it is "unlevered" as it is the same irrespective of the actual amount of leverage. The answer to the conundrum you refer to exists when a company has zero leverage hence its equity beta equals its asset beta.
z4chris99 said:
what question you trying to answer?
i have masters in this crap
You have a masters in this? You must have the brain the size of a...very large brain.i have masters in this crap
My question is this; is asset beta merely figuring out the sensitivity of a company's specific asset to market risk? e.g. working out how a particular oil rig is performing in reference to the market, rather than the oil company that owns that oil rig and how it is performing as a whole?
My book (Brealey, Myers, Allen) phrases it thus "the after tax WACC depends on the average risk of the company's assets, but it also depends on taxes and financing. It's easier to think about project risk if you measure it directly. The direct measure is called the asset beta"
A formula is then included that gives a beta for both debt and equity for the asset beta-however it states that the asset beta is an estimate of the average risk for a total business. If a business is the sum of its assets, and we are told to assess each asset of that company as if it were an individual company, how can the asset beta give us an average risk? What if a company has diversified interests?
Unless I'm being thicker than average, and missing the point, a company with debt and equity will have effectively two Betas to be aware of.
Beta being the market return of either the equity or debt market that the company's securities are listed on.
Of course there'll be some correlation between the two as part of the whole, but they'll not be 1, unless it's going down the tubes in a big manner.
Beta being the market return of either the equity or debt market that the company's securities are listed on.
Of course there'll be some correlation between the two as part of the whole, but they'll not be 1, unless it's going down the tubes in a big manner.
daveco said:
You have a masters in this? You must have the brain the size of a...very large brain.
My question is this; is asset beta merely figuring out the sensitivity of a company's specific asset to market risk? e.g. working out how a particular oil rig is performing in reference to the market, rather than the oil company that owns that oil rig and how it is performing as a whole?
My book (Brealey, Myers, Allen) phrases it thus "the after tax WACC depends on the average risk of the company's assets, but it also depends on taxes and financing. It's easier to think about project risk if you measure it directly. The direct measure is called the asset beta"
A formula is then included that gives a beta for both debt and equity for the asset beta-however it states that the asset beta is an estimate of the average risk for a total business. If a business is the sum of its assets, and we are told to assess each asset of that company as if it were an individual company, how can the asset beta give us an average risk? What if a company has diversified interests?
Assuming you are calculating your betas using the movement in a whole company's share price relative to a market benchmark, then you will of course end up with a beta that represents an "average" asset across all assets a company owns. This of course could be nonsense when you are looking at an asset that is materially different to others within the company (whether due to country / industry risk). In theory if you calculated all the betas for each company asset that factored in the variances in industry, country, size and averaged them out then, apart from a headache, you would end up with the company beta (setting aside any portfolio diversity benefits). This is partly why companies will have their WACC, but will then often use a specific hurdle rate for a one off investment decision. This hurdle rate should capture the differences in industry/business/country risk fundamentals.My question is this; is asset beta merely figuring out the sensitivity of a company's specific asset to market risk? e.g. working out how a particular oil rig is performing in reference to the market, rather than the oil company that owns that oil rig and how it is performing as a whole?
My book (Brealey, Myers, Allen) phrases it thus "the after tax WACC depends on the average risk of the company's assets, but it also depends on taxes and financing. It's easier to think about project risk if you measure it directly. The direct measure is called the asset beta"
A formula is then included that gives a beta for both debt and equity for the asset beta-however it states that the asset beta is an estimate of the average risk for a total business. If a business is the sum of its assets, and we are told to assess each asset of that company as if it were an individual company, how can the asset beta give us an average risk? What if a company has diversified interests?
Hope that helps - sounds like you're on top of it, just getting distracted by a too literal reading of Brealey & Myers.
Sounds like you have the difference between equity beta and asset beta (unlevered) down - it's just the financing.
Any company will have an asset beta, whether it is a company with just one asset or diversified.
And you have the formula to calculate that in each case.
You could also calculate the asset beta of each individual asset within the diversified company.
What you can't do is simply take some weighted average of the individual asset betas for a diversified company and calculate the overall company group asset beta. The diversification impact can be significant.
Imagine you own and oil rig and a trucking company.
Oil rigs might have a high beta since their value is very sensitive to the price of oil.
As oil goes up, they are MORE valuable.
The trucking company is also high beta since it too is sensitive to the oil price. But in this case since they buy oil-derived fuel, they become LESS valuable as the oil price rises.
Two high beta assets in this case does not necessarily translate to a high beta conglomerate!
Any company will have an asset beta, whether it is a company with just one asset or diversified.
And you have the formula to calculate that in each case.
You could also calculate the asset beta of each individual asset within the diversified company.
What you can't do is simply take some weighted average of the individual asset betas for a diversified company and calculate the overall company group asset beta. The diversification impact can be significant.
Imagine you own and oil rig and a trucking company.
Oil rigs might have a high beta since their value is very sensitive to the price of oil.
As oil goes up, they are MORE valuable.
The trucking company is also high beta since it too is sensitive to the oil price. But in this case since they buy oil-derived fuel, they become LESS valuable as the oil price rises.
Two high beta assets in this case does not necessarily translate to a high beta conglomerate!
Eric Mc said:
What are you all talking about?
Ah, I forgot you're an accountant. When investing in a company, you will want to know the Expected Return and Risk I.e. the variability of the Expected Return. Beta is relative volatility (to the market). But then you may want to break down the Beta into the corresponding Debt and Equity components of a company.
daveco said:
z4chris99 said:
what question you trying to answer?
i have masters in this crap
You have a masters in this? You must have the brain the size of a...very large brain.i have masters in this crap
anyway, looks like the above answers have it covered.
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