Can somebody tell me if this reasoning is correct? Without entering into calculations: 1. Without pension assets and liabilities Equity beta = A Total asset beta = (weight of equities vs total liabilities) x Equity beta = B Total assets = operating assets (ie, there are no pension assets) Total asset beta = Operating asset beta = B We use B to calculate wacc 2. With pension assets and liabilities Equity beta = A Total liabilities = previous liabilities + pension liabilities Total asset beta = (weight of equities vs total liabilities) x Equity beta = C Pension assets beta = D (given) We solve for operating assets beta (E) so that weighted sum of E + D = C We use C to calculate wacc 3. What if we increase equities inside pension assets? Pension assets beta increases I keep constant operating assets beta This means that total asset beta has gone up = If I want to compensate in the liability side, as equity beta is constant, I should increase the weight of equities Vs debt 4. What if we decrease equities inside pension assets? Pension assets beta decreases I keep constant operating assets beta This means that total asset beta has gone down = If I want to compensate in the liability side, as equity beta is constant, I should decrease the weight of equities Vs debt does it make sense? thx
errata: - in 2, we use E to calculate wacc
Great post. Thanks for the recap.
I’m getting stuck on the fact that given a higher total asset beta…how does this lead to/ relate to having a lower amount of Liabilities held on the Balance sheet? beta is a risk measure so how does this relate to the equation; Assets = Liabilities + Equity can someone clear this up for me? perhaps some insight? thanks a
this is how I see it: beta of assets = beta of your operating assets + beta of your pension assets (weighted for % of operating assets and pension assets over total assets) beta of liabilities = beta of regular debt + beta of pension liabilities + beta of equity (weighted for % of regular debt, pension liabilities, and equity over total liabilities) but beta of regular debt = 0, and beta of pension liabilities = 0 this means that beta of liabilities = weight of equities x beta of equities if beta of equities is constant, the only way to increase (or decrease) beta of liabilities is increasing (or decreasing) weight of equities (against weight of debt) this is, of course, according to cfa and schweser where it seems that, once I incorporate pension assets and liabilities into the calculations, apparently beta of operating assets and beta of equity is constant, which means that if I “play” with pension assets beta (ie, how much I invest in equities in my pension portfolio), I can only compensate changing the weight of equity in my balance sheet But, again, I wrote this post because I am not sure if this is correct or not, I would appreciate your comments what do you think? thx
this is how i think of it… if there is an increase in total asset beta, it implies increased risk in the company. if management decides that they wish to keep the shareholder’s risk the same (ie, keep equity beta the same), they need to lower risk somehow to counteract the increase in total asset risk. the way they do it is to decrease financial leverage (or the D/E ratio). by increasing the amount of equity and decreasing the amount of debt, the company is able to decrease the risk to shareholders. they will increase equity (in other words, decrease the D/E ratio) until the equity risk is back to the original level. does that make sense?
eklypse Wrote: ------------------------------------------------------- > this is how i think of it… > > if there is an increase in total asset beta, it > implies increased risk in the company. if > management decides that they wish to keep the > shareholder’s risk the same (ie, keep equity beta > the same), they need to lower risk somehow to > counteract the increase in total asset risk. > > the way they do it is to decrease financial > leverage (or the D/E ratio). by increasing the > amount of equity and decreasing the amount of > debt, the company is able to decrease the risk to > shareholders. they will increase equity (in other > words, decrease the D/E ratio) until the equity > risk is back to the original level. > > does that make sense? agree
Yuk, I thought I’d left this stuff behind at L2. What study session is this from again?
second one from institutional investors, something like “allocating pension assets” or something like that, I don´t have the books here. It is actually 4-5 pages only in both cfa in schweser, don´t worry
I guess my concern is I don’t understand how the conclusions come from the eq’n of; total asset beta = ($equities/$total assets) x (beta equities) + ($debt/$total assets) x (beta debt) total asset beta = ($equities/$total assets) x (beta equities) + 0; because, beta debt = 0 therefore we have total asset beta = ($equities/$total assets) x (beta equities) now if total asset beta increases, and given that we want a constant beta? how does it work from here? I can see how we increase the equity, but why decrease the liability?
so that total liabilities (debt + equity) remain constant and equal to total assets if the quantity of the right hand must be constant, any increase in equity must be compensated with a decrease in debt, and viceversa (any decrease in equity must be compensated with an increase in debt) anyway, that goes more into the mathematics, which are not the objective of this LOS. I would rather focus more on the wording of eklypse
Thanks hala! eklypse! If that’s the approach and transition, that’s ok! I can understand that. I just needed to make sure that was how everyone was increasing equity (and therefore decreasing liabilities) big help! thank you all!
I can’t connect Los 22b and Los 22c Before we add pension assets and liability does operational beta = total asset beta? In Schweser Los 22b after we add pension assets and liability we calculate total asset beta = equity beta*old equity MV/(old assets + pension assets) From this formula it seems that total asset beta will always get smaller when we add pension staff, and how pension assets are distributed between equity and debt wouldn’t matter total asset beta = w*operational + W*pension asset beta Now Los 22c writes: When the firm’s pension assets are weighted more toward equities the result will be increased risk in its pension assets with an accompanying increased asset beta. This will cause the total asset beta to increase and the risk of the firm’s capital to increase ********************** I just can’t connect it 
No, wthout pension assets, you have, Operational Beta not Total asset beta. operational beta is what you need to determine your wacc with pension assets, you have Pension asset beta and a Total Asset beta which you back out of to find your operational beta your allocation between stock and debt within your pension assets is what is going to give you your pension asset beta. your allocation between Equity and Liabilties is what is going to give you the Total asset beta given those two you back out and find the Operating asset beta. then you go look at the Total asset beta and manipulate it if investor’s want a constant equity beta to derive what you need to do to your Equity and Liability position. hope that helps. a.
Ok, please correct me if i am wrong: Whenever we incorporate pension assets and liabilities(doesn’t matter what % of pession asset is equity) to WACC not adjusted for them, WACC will decrease. The asset beta will also decrease. Now, after pension assets and liabilities were incorporated and we want to maintain specific equity beta and operating asset beta we can manipulate debt/equity ratio of the firm. If pension assets composition became more equity then based on equation firm asset beta = operational beta + pension beta firm asset beta will increase. Since equity beta = asset beta*debt/equity, we need to lower debt and increase equity capital
yes, WACC will decrease and yes, if pension beta increases, firm asset beta increases, and to keep equity beta same, you need to increase equity and decrease debt.
thanks! I think I got it