Beta estimate, please help!

CFA Level II
#1

Hi guys,

This is related to the beta estimate stuff.

So for thinly traded or unlisted companies, the notes say:

“THE UNLEVERING PROCESS ISOLATES THE SYSTEMATIC RISK. IT ASSUMES THAT THE THE DEBT IS HIGH GRADE”.

i am not sure if i fully understand that statement…

because first i thought the BETA itself already reflects systematic risk…

2). is systematic risk for high grade generally lower than systematic risk for spec grade?

thanks a lot guys!

#2

does it actually mean like it doesnt take into account the systematic risk OF it being spec grade?

#3

From what I understand you are mixing a few components here.

  1. Yes, Beta is itself already reflects systematic risk. However it is based and influenced by the capital structure of the firm.

  2. You are starting with the equity beta of a firm (selected benchmark), which is a measure of volatility in price movements compared to the overall market. Firms with high debt to equity ratios are more volatile than low (D/E) firm. You then strip out the effect of the capital structure(unlever) the beta. This gives you Asset Beta. This is the volatility of the business/industry of the benchmark. You then will lever the asset beta to the subject capital structure to get your answer of the estimate of the beta.

  3. “The debt is high grade” is used to fulfill the assumption required to use the formulas for this problem. High Grade debt should have a beta of approx. 0

Hope this helps.

#4

so if the debt is not high grade…the beta should be higher

#5

Yes, but you are getting away from you original question by oversimplifying

#6

essentially the bea is affected by the overall business…the capital structure…as well as the quality of the debt in the capital structure…alright…

#7

essentially the bea is affected by the overall business…the capital structure…as well as the quality of the debt in the capital structure…alright…

is this correct?