A PRESENTATION ON CONCEPT OF BETA

What is Beta?
The beta coefficient is the relative measure of sensitivity of an assets return to change in return on the market portfolio. It can be viewed as an index of the degree of the responsiveness of the securitys returns with the market return.

 The beta coefficient, , is calculated by relating the returns of a security with the returns for the market. Mathematically, the beta of security is the securitys covariance with the market portfolio divided by the variance of the

market portfolio.

 When >1 =the security is more risky.

When <1=the security is less risky.

 It can be calculated as:

= COV(S,M)
2 m

Eg:- Following information is available in respect of a security, S and the market portfolio M.
Probabilities S .3 .4 .3 10 16 32 Return M 11 20 19

Find out the of the security.

In order to find out the beta of the security, various figures have been calculated and summarised as follows:
S Avg expected return Standard Deviation Variance 19% .89 .00792 .00204 M 17% .0395 .00156

.0024 .00156

= 1.3

Equity and Debt Beta

In general, investors can invest in company through bonds and stock. Bonds represent a debt to the company and investors are compensated for the use of their funds with interest. Stocks represent a share of ownership and stockholders are compensated with share price appreciation, but do not have to be paid back if the price of the shares falls. Stocks are considered riskier than bonds and therefore offer a higher possibility for return. The risk of investing in a particular stock is measured with a metric referred to as equity beta.

Company Beta
Represents how the companys returns are effected with respect to the changes in the market conditions.

Co. Beta= Eq. Beta(

E )+ Deb. Beta( D E+D E+D

Asset Beta
Asset beta, by definition, reflects the beta of a company without debt. It is sometimes referred to as unlevered beta allows the evaluation of the volatility of a company's stock without this debt benefit Asset beta = B/(1+(1-T)*(R)) B=companys beta T=tax rate, income tax paid by net income before taxes R=debt equity ratio Equity Beta measures the systematic business risk and financial risk of a company

Asset Beta measures the systematic business risk only

Systematic risk that relates to macro economic factors Unsystematic risk is business related risk which can be reduced/eliminated thought diversification

 It is used in the context of general equities. The Beta

PORTFOLIO BETA

of a portfolio is the weighted sum of the individual asset betas, According to the proportions of the investments in the portfolio. E.g., if 50% of the money is in stock A with a beta of 2.00, and 50% of the money is in stock B with a beta of 1.00,the portfolio beta is 1.50. Portfolio beta describes relative volatility of an individual securities portfolio, taken as a whole, as measured by the individual stock betas of the securities making it up. A beta of 1.05 relative to the S&P 500 implies that if the S&P's excess return increases by 10% the portfolio is expected to increase by 10.5%

 A measure of a portfolio's volatility. A beta of 1 means that the portfolio is neither more nor less

volatile or risky than the wider market. A beta of more than 1 indicates greater volatility while a beta of less than 1 indicates less. For example, if a portfolio consists of two securities, one valued at $15,000 and having a beta of 0.9 and the other valued at $10,000 and having a beta of 1.5, the portfolio beta is (0.9) ( $15,000/$25,000 ) + (1.5)( $10,000/$25,000 ), or 1.14

The relative volatility of returns earned from holding a specific portfolio of securities. A high portfolio beta indicates securities that tend to be more volatile in their price movements than the market taken as a whole. Portfolio beta is calculated by summing the products of each security's beta times the proportional weight of the security in the portfolio.

PROJECT BETA
Project beta basically studies the systematic risk factor of any project . It basically measures the risk associated with a certain

project . It is a part of capital budgeting decisions. It is a measure of sensitivity. For eg a company is starting up a project . In order to judge the sensitivity of a project a project beta is calculated of a company.

GEARED BETA
An indication of the systematic risk attaching to the returns on ordinary shares. It equates to the asset Beta for an ungeared firm, or is adjusted upwards to reflect the extra riskiness of shares in a geared firm., i.e. th Geared Beta. In the Capital asset pricing model (CAPM), it is the relevant measure of total equity risk.
Also known as Geared beta . It is very well related to the debt concept

UNGEARED BETA

The asset beta, or corporate beta, or business beta, is a measure of the business risk in a sector; that is the business risk alone, unaffected by any financial risk that would be introduced by debt financing on the balance sheet (i.e. gearing). Each business sector has its own unique risks and so each business sector will have its own asset beta. It is not possible to convert an asset beta from one sector into an asset beta for another sector; each sectors asset beta has to be derived from statistical analysis (using least squares linear regression techniques).

Since the asset beta reflects purely business risk, a company with only equity finance on its balance sheet will find that its equity beta is the same as the sectors asset beta. This is because the company has no debt finance and so does not expose its shareholders to the financial risk associated with debt finance, hence the asset beta is also called an ungeared equity beta.

Unlevered Beta
A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta of a company without any debt. This provides a measure of how much systematic risk a firms equity has when compared to the market. Unlevering of beta removes any beneficial effects gained by adding debt to the firms capital structure. Comparing Companies unlevered betas gives a better idea to an investor about how much risk they will be taking in when purchasing a firms stocks

Formula of unlevered beta

BU = BL [1+(1-TC)*(D/E)]
Where, BU = Beta of Unlevered firm BL =Beta of a firm with Levereage TC = Tax rate. D/E = Debt/Equity ratio of the company

Problem
A Heavy Tech company has a Beta of 1.2, with half of debt against the equity. Estimate the new beta if the company goes 100% on equity. Assuming the tax rate of 40% for the company. Solution: D/E ratio= =0.5 Now, Unlevered Beta = BL

[1+(1-TC)*(D/E)] = 1.2 [1+(1-0.40)*0.5] = 0.92

Levered Beta
Levered Beta is the beta of a firm with Financial Leverage . The levered beta of a firm is different than the Unlevered Beta as it changes in positive correlation with the amount of debt a firm has in its financial structure. If a firm had zero debt, its levered beta and unlevered beta would be the same. In general, beta measures the responsiveness of a firm's stock to the overall market. As a firm increases its financial leverage the firm's levered beta increases. Formula for Levered Beta,

BL

= BU [1+(1-TC)*(D/E)]

Problem
A company with 100% equity has a beta of 0.55. If the company raises the debt of 1700 crore against the equity of 1500 crore , then estimate the value of new beta, assuming the tax rate to be 36%. Solution: D/E ratio=1700/1500=17/15 Now, BL = BU [1+(1-TC)*(D/E)] = 0.55[1+(1-.36)*(17/15)] = 0.55[1.64*1.133333] = 0.55*1.858666 = 1.022

Stock Beta
Stock beta" is a financial term that measures the risk or volatility of a stock. the stock movements are greater than the stock market, the beta must be greater than one. If the stock movements are less, the beta value must be less than one. A large beta equals a larger risk and reward closing stock prices for your stock and the closing prices for the index and plug them into the beta formula. "Beta = Covariance (stock versus market returns) / Variance of the Stock Market."