Capital Structure and Beta

CFA Level I
#1

Hello,

I am studing Corporat Finance Module and I must do a report about the impact of capital structure on systematic risk (measured by beta). so I have some issues there.

1- In some companies the beta is less than zero. why?? what factors lead to that.

2- some companies when increase debt, the beta also increase. why??

3- some companies when decrease debt, the beta increase. why?? and what are the factors for that??

I need these answers to finish my report. I am looking for your help. thank you.

#2

  1. Beta = cov(stock returns, market returns) / var(market returns). Covariance can be negative, exactly when the behavior of the 2 variables analyzed are contrary (one goes down, the other goes up). However, this behavior is not constant, so you will never have a perfect negative correlation (full negative cov). Thus, negative beta can exist when the returns of the stock is negative related to the market returns.

  2. I would be pretty sure all companies encounter a beta rise when their debt level rises. Beta is a measure of systematic risk, which means market risk. Market risk does not account for default risk, so the beta adjusts the unlevered beta for the debt added. Look the formula for levered beta, D/E ratio is considered, which controls for debt increments.

  3. Could be coincidence that exactly when debt decreases the beta increases not because the debt, but other factors?. A change in the overall perceived risk in the market or in a certain industry can change asset betas, making them to rise if debt levels decrease. Never seen a beta incrase solely for a decreased debt level. Sounds interesting, can you share the case?

Hope this helps