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There is no point in simply setting me a test question!!! You must have an answer in the same book in which you found the question, and so ask about whatever it is in the answer that you are not clear about.
The equity beta measures the riskiness of shares in a company. This is determined by the riskiness of the business (which is measured by the asset beta) and the level of gearing in the company (because higher gearing makes the shares more risky).
All of this is explained in detail, with examples, in my free lectures on CAPM.
I am very sorry for the trouble that the structure of my question may have caused you. Actually, what I wanted to know if we are taking about the riskiness of the business and the gearing of a company aren’t we talking about the same thing? Because the riskiness of a business is perceived by its debts, that it’s gearing?
It has not caused me any trouble 🙂
The riskiness of a business is certainly not determined by its debts!!
The risk of the business is determined by the type of business – some types of businesses are more risky than other types of business.
The effect of gearing is not to make the business itself more risky. What gearing does is make the shares/equity more risky than they otherwise would be.
The asset beta measures the risk of the business. The equity beta measures the risk of the shares. If there is no gearing then the equity beta is equal to the asset beta. When there is gearing, the shares become more risky and the higher the gearing the higher will be the equity beta.
Again, have you watched my free lectures on this?
Thanks for your reply.
Yes, I have watched them.
Actually, you are indeed right since the risk to a business is firm-specific. Since it is by removing this risk that we can calculate the asset beta.But what I could not find in the lectures is exactly what factors affected a company’s equity beta apart from the gearing?
Because for the amount of marks that the question provided, is stating and explaining only the gearing factor enough?
The lectures explain everything with regard to the factors affecting the equity beta,
There are only two factors – one is the level of business risk which is measured by the asset beta. The other is the level of gearing in the company. If there is no gearing then the equity beta is equal to the asset beta. The higher the gearing then the greater the equity beta is over the asset beta.
For 6 marks you need to explain why gearing creates extra risk for the equity (because of the amount of fixed interest being paid as again). You also need to explain what causes the business risk (it being due to a combination of the type of business and the way the company has structured its costs in terms of the variable and fixed costs – the operational gearing).
I assume that you have an answer in the same book in which you found the question, and it should be clear from the answer what was expected of you.
Now, I have a clearer image of what is expected on my part. Thanks for your explanation and time. I am really gratefully to you as your explanations have been really concise.
Unfortunately, I do not have the answer to this question. I have gone multiple times through the BPP book looking for parts explaining the factors affecting the equity beta but there were none.
I apologise for what I am going to say but to what specific lecture are you referring at when you are saying the lectures explain everything with regard to the factors affecting the equity beta because I am a bit confused as I have been questioning whether I have misinterpreted the question.
The equity beta is explained in the lectures on CAPM. However the lectures are a complete course and are intended to be watched in chapter order. Factors affecting the risk of shares (and therefore the equity beta) are relevant in lots of places in the exam and are mentioned in several of the lectures.
(You should really be using a Revision Kit from one of the ACCA Approved Publishers – they have answers and explanations 🙂 )
I am really grateful to you for everything to answering my questions so quickly and also for giving advice. I thank you a lot and I am really pleased to be part of the OpenTuition Community.
You are really doing a great job. Wish you good luck in your future endeavors and thanks again for helping me. 🙂
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