Unlevered Beta - Explained
What is an Unlevered Beta?
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Table of ContentsWhat is an Unlevered Beta?How Does an Unlevered Beta Work?Systematic Risk and BetaExample of Unlevered Beta
What is an Unlevered Beta?
An unlevered beta is a risk measurement technique that measures the market risk of a company without considering debts. It is also known as asset beta. An unlevered beta seeks to find the beta of a company excluding the impact of debt or financial leverage of the company. In other words, unlevered beta is the beta of a company after removing the effects of financial leverage or debt.
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How Does an Unlevered Beta Work?
Beta is the measurement of market risk, it evaluates the regression of a stock against the benchmark in the market, popularly called market index. When measuring the beta of a company, attention is often paid to the rate of the company's debt to its equity (this is measured by leverage). Unlevered Beta however measures the market risk of a company without giving any regard to leverage or the impact of debt. All advantageous and disadvantageous effects of debt in a company are excluded when measuring is unlevered beta. Here are the key takeaways:
- Unlevered beta differs from levered beta in that it measures the market risk of a company without the effect of debt.
- Levered beta is equity or just beta. Unlevered beta is asset beta.
- When measuring the beta of a company, the impacts of leverage our effect of debts are assessed.
- Unlevered beta gives no consideration to the effects of debt or leverage when estimating a company's beta.
Systematic Risk and Beta
Risks that occur to a company that are beyond the company's control are called systematic risks. It is quite difficult to avert or subvert systematic risks. For instance, risks resulting from wars, inflation and natural disasters are difficult to control, they are examples of systematic risk. Beta is also a metric that measures the level at which a stock or portfolio had been affected by volatility or systematic risk. High volatility of stock suggests higher risk while low volatility posits lower risks. When a company has a beta of 1, it means it's systematic risk is the same as that of the broader market. A beta of 2 means the company is more volatile than the market, a beta less than 1 means the company is not as volatile as the overall market.
Example of Unlevered Beta
Debt or financial leverage affects the performance of a company significantly. In order to remove the effects of debts and leverage, unlevered beta is used. Unlevered beta measures the performance of the company without giving any consideration to debt or leverage. The Formula for calculation unlevered beta is;
BU = BL / [1 + ((1 - Tax Rate) x Debt/Equity)
A positive unlevered beta attracts investors because it indicates that the company's stocks are expected to rise in price. If the unlevered beta is negative, investors invest when prices of stocks are expected to decline.