Question

Other things held constant, an increase in financial leverage will decrease a for-profit business’s market risk as measured by its beta coefficient.

True or False?

Answer 1

False because if the financial leverage is growing then the Financial risk will start growing and this increase in the financial risk will increase the beta. Furthermore this increase in financial leverage is also responsible for the increase in the Bankruptcy Risk.

Remember the beta factor is directly proportional to market risk (Systematic Risk) this means if the market risk is increasing then the beta will also increase and if the market risk is decreasing then the beta is decreasing. This is evident from the fact that people require more returns from their investments in Asia than USA. The reason is that the Market risk in Asian countries is more than United states of America.