Final Answer:
Yes, the levered beta of equity typically exceeds the asset beta.Therefore the correct option is 1.
Step-by-step explanation:
The levered beta of equity typically exceeds the asset beta. Levered beta accounts for the financial leverage effect on a company's equity, considering the impact of debt financing. Mathematically, the levered beta of equity is calculated using the asset beta and the company's debt-to-equity ratio. When a company employs financial leverage (using debt alongside equity), it amplifies the volatility of equity returns compared to the overall asset beta. As a result, the levered beta of equity tends to be higher than the asset beta. The formula for levered beta is βL = βU * (1 + (1 - Tax rate) * (D/E)), where βL is the levered beta, βU is the asset beta, and D/E represents the debt-to-equity ratio. This formula demonstrates how financial leverage influences the equity beta, indicating that the levered beta will surpass the asset beta due to the effect of debt on equity volatility. Considering this relationship, the levered beta of equity is expected to be greater than the asset beta in most cases.
Understanding the concept of beta helps in assessing risk and expected returns for investors. Asset beta represents the volatility of a company's assets without considering its capital structure. However, when debt is introduced into the capital structure, it impacts the risk profile of equity, leading to a higher levered beta. The leverage effect magnifies the sensitivity of equity returns to market fluctuations, resulting in a higher beta for equity. This relationship is crucial in financial analysis and portfolio management, as it aids in evaluating the risk-adjusted returns and making investment decisions based on the risk profiles of various assets or companies.
In summary, the levered beta of equity typically exceeds the asset beta due to the inclusion of financial leverage, which amplifies the volatility of equity returns compared to the overall asset volatility. This understanding is fundamental in financial modeling, risk assessment, and investment analysis. Therefore the correct option is 1.