Beta is an up to the minute approach that is used in financial analysis in order to measure the instability level that is employed for analyzing the risk in investment portfolios. The systematic risk calculation is done in beta approach that has immense value in the business. There are two types of beta approaches are in practice these days known as Levered Beta and Unlevered Beta.In the business sector of today, if you wish to analyze the risk in the investment portfolios then the use of the levered beta and unlevered beta is necessary for you. When you know the difference between the levered and unlevered beta then you will be in a position to pick the one in order use any in your analysis. In the Levered beta approach, the debt of the company field is taken into account. On the other hand, the unlevered beta is not concerned with the debt held by the firm. The main function of the Unlevered Beta is to calculate the risk of a company that has no debt next to the risk of the market. In both the approaches, the use of the complex mathematical expressions are used however, it is said that the Levered Beta is more reliable and useful as compared to the Unlevered Beta since the calculations of the Levered Beta are more accurate.
The main role of the Levered beta is to measure the sensitivity of a security’s or portfolio’s trend. The purpose of this tendency is to check the company’s criteria that whether it is with the market or against the market. This is the major cause that you are able to observe the consideration of the company’s debts in the computation while using the Levered Beta method. The findings interpretation of the levered beta is quite simple as a positive value will represent that the security’s value will perform with the market and the negative value will show that the security’s value will perform not in the favor of the market. When you see the value of zero in the levered beta result, it means that the security has no association with the market. In the calculation of the Levered beta, you need to take into account the debt that the company owned. But after taking the company’s debt into consideration, there will be a great chance that a beta value may result in closer to zero because of the tax benefits.
Another calculation of the security’s performance in relation to market movements is known as unlevered beta that is widely used across the globe these days. In the unlevered beta estimate approach, the risk of a company is considered that has no money owing next to the risk of the market. In other words, the debt factor is not measured in the unlevered beta calculation at the time when getting the beta figure. It means that the effect of leverage is totally erased from the calculation of the beta calculation. Thus, it is said that the figure derived from the unlevered beta is more realistic. The formula used for unlevered beta calculation is shown below:
Unlevered Beta = BL / [1 + (1 – TC) × (D/E)]
- BL means the levered beta
- TC indicates the tax rate
- D/E is the debt to equity ratio of the company
- The Levered beta is the method in which the company’s debt are considered that may result in a beta value closer to zero in most of the cases because of the benefits of tax. In the measurement of the security’s performance performed by unlevered beta technique, the risk calculation of a company is accomplished that has no debt against risk of the market.
- The levered beta is thought to be more rational because in this computation, the company’s debt is taken into account.