- This topic has 3 replies, 2 voices, and was last updated 9 years ago by
.
- Posts
which of the following is/are correct
1. asset beta reflects both the business and the financial risk
2. total risk is the sum of systematic risk and unsystematic risk
3. assuming that the beta of debt is zero will understate the financial risk when ungearing an equity betaA. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2,3the correct answer is A.
i chose C.
i admit that even tho i understand the mechanics of ungearing and gearing, i am unable to get the logic/understanding of this process.
in 3, i assumed he was talking about Bd, which for f9 is taken as zero, therefore i said that since a term of the formula is zero, the the financial risk will be understated.
i have listened to ur lecture but i will be grateful if u cd write a few lines to explain as to why 3 is incorrect.
regards
The asset beta is always lower than the equity beta, because the financial (gearing) risk is being removed.
If the debt beta was not zero, but was (say) 0.1 (it would always be low), then if you look at the formula then the asset beta would end up being a little higher then what it would be when we assume that the debt beta is zero.
So the true asset beta would really be a little bit higher than the asset beta that we calculate (using a debt beta of zero).
Since the asset beta we calculate is therefore a bit lower than it really should be, it means we have effectively taken out too much financial risk (i.e. we have effectively overstated the financial risk).
apologies and thank u i advance for ur patience. am still trying to grapple. but i will get there..:)
when he says “financial risk” he is referring to the equity beta?
- You must be logged in to reply to this topic.