For the levered ﬁrm the equity beta is __________ the asset beta.

Question

Quizplus · Accepted Answer

The equity beta reflects the risk that is specific to the shareholders of the levered firm, while the asset beta reflects the total risk of the firm including both equity and debt. Since debt is cheaper than equity capital, the leveraged firm uses debt financing to increase returns to equity shareholders. However, this also increases the financial risk of the firm as debt holders have priority in receiving their payments over equity holders. Therefore, the equity beta is higher than the asset beta to reflect the additional risk that equity holders bear due to the use of debt financing.

For the Levered ﬁRm the Equity Beta Is __________ the Asset