The use of leverage (borrowing money to invest) increases the equity beta because it introduces additional financial risk to equity holders. However, it does not affect the asset beta, which reflects the business risk inherent in the firm's operations, independent of how it is financed.

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The Use of Leverage

Question 15

Multiple Choice

The use of leverage:

A) increases both the asset and the equity betas.
B) decreases both the asset and the equity betas.
C) decreases the equity beta and increases the asset beta.
D) increases the equity beta but does not affect the asset beta.
E) decreases the equity beta but does not affect the asset beta.

Correct Answer: