Difference Between Asset Beta and Equity Beta Formula
Hey guys,
can someone please explain the difference between equity and asset beta? And what each one is used for in IB.
I have been trying to find some decent info on Google for quite a while now and haven't had any luck.
Thanks!
Equity Beta
Equity Beta is also commonly refered to as levered beta and offers a measure of how volatile a given stock's price movement is relative to the overall market's movement.
Equity Beta accounts for the company's capital structure - meaning that if the company has loaded up on debt it will be more volatile than companies that have less debt within the capital structure.
This is the beta that is typically found on financial websites such as Yahoo Finance.
Equity Beta vs. Asset Beta
Asset Beta measures how volatile the underlying business is without considering capital structure. You calculate asset beta by removing the capital structure impact on the equity beta. Asset beta is also frequently refered to as unlevered beta.
This beta allows investors to compare the relative volatility of assets stripping out the effect of capital structure choices.
This is important as it allows investors to find an optimal capital structure by finding the average asset beta of industry and then taking the average asset beta of the industry and then "re-levering" it with the target company's capital structure with the following equation.
Asset Beta = equity beta / (1+(1-taxrate)*(debt/equity ratio))
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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).
Asset beta = how volatile the underlying business is, irrespective of capital structure. You calculate asset beta by stripping out the capital structure impacts on the equity beta.
asset beta = equity beta / (1+(1-taxrate)*(debt/equity ratio))
An asset beta is important because you can compare companies and not have the comparison be affected by capital structure choices. What is frequently done to figure out a company's discount rate is to take the average asset beta of the company's peers and then re-adjust that asset beta into an equity beta based on what you think the right long-term capital structure is.
Hope that helps some.
I have been having issues with equity and asset beta. This explanation was explicit. Thank you.
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Downtown is right on the money. You'll also sometimes hear asset beta referred to as "unlevered beta".
also, the application is that if you're looking at a company and you want to compare it to a set you'll have to unlever and relever it's beta...
This one always gets me confused.
What about when people refer to the systematic and unsystematic components of beta and extend the definitions with other terms like business and diversifiable risk. Would it be right to say that asset beta is the unsystematic part of equity beta? If not, how do all the terms relate?
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