Definition: Levered beta is a financial calculation that indicates the systematic risk of a stock used in the capital asset pricing model (CAPM).
What Does Levered Beta Mean?
What is the definition of levered beta? A key determinant of beta is leverage, i.e. the level of the firm’s debt compared to equity. The systematic risk includes the different types of risk that may affect the stock performance, including macroeconomic factors, political events, etc., and it cannot be leveraged through diversification.
Usually, a beta equal to 1 indicates a stock’s risk equal to the market risk; a beta of less than 1 indicates a stock’s risk lower than the market risk, and a beta of greater than 1 indicates a stock’s risk greater than the market risk. To calculate the leveraged beta, we need to know the unlevered beta and the debt-to-equity ratio.
Let’s look at an example.
Mark works as a financial analyst at Goldman Sachs. One of his daily tasks includes the calculation of a stock’s leveraged beta to determine the effect of leverage on the stock’s risk. Currently, he analyzes a stock with a beta 1.25, and a debt-to-equity ratio 13%. Also, the company is taxed at 35%.
Mark calculates the unlevered beta formula of the stock
beta / 1 + (1 – tax rate) x (debt / equity) = 1.25 / 1 + (1 – 35%) x 13% = 1.33.
Then, he calculates the levered beta formula of the stock
unlevered beta (1+ (1-t) (Debt/Equity)) = 1.33 x (1 + (1-35%) x 13% = 1.45.
Then, he constructs an excel spreadsheet to calculate the effect of leverage based on different levels of debt, as follows:
Therefore, based on different levels of debt, the debt to equity ratio affects the level of beta, thereby increasing leverage.
Define Levered Beta: LB means an investment measurement used to calculate the risk involved with purchasing an asset with debt.