Beta Finatics (Excel)

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					Beta Basics
    What is beta ?
    Beta measures the sensitivity of an asset with the broader market.
    For e.g. HLL's returns have a co-movement of 0.9 with that of the SENSEX.
    i.e. if SENSEX moves up by 1% HLL will move by 0.9% and if SENSEX falls by 2% HLL will fall by 1.8%

    How is it measured / calculated / estimated ?
    There are 2 popular approaches - Regression & Covariance method

    What drives beta ?
    Economy                                          Industry
     absolute growth                                   FII / FDI inflow
     relative growth                                   Cyclicity
     sustainable growth                                Government regulation / control
     foreign threat                                    availability of funds
     threat from natural calamities                    Barriers to entry
     mobilisation of funds                             threat of substitutes & degree of elasticity
     currency convertibility                           degree of competition
                                                       degree of fragmentation/concentration
                                                       cartelisation / monopoly /
                                                       oligopoly / monopolistic
                                                       competition
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ll fall by 1.8%




              Company
               absolute growth
               relative growth
               sustainable growth
               risk from operating leverage
               risk from financial leverage
               Revenues - fragmented or highly
               concentrated ?
               market share of the company &
               degree of influence
Beta Types & FAQs

   FAQs                     Levered                                             Unlevered
   A.k.a                    Equity beta/Raw beta                                Operating / Asset beta

   Variants                 Re-levered beta (Levered to a companies
                            'Target' Debt-Equity)

   Meaning                  It reflects both types of risks that a              It reflects the risk of operations alone
                            shareholder has to bear. i.e. operating and         resulting from fixed costs such as
                            financial leverage. The raw beta that one           depreciation, rent & salaries. For this r
                            calculates from market data                         It is also called Asset beta - Risk relate
                                                                                efficient use of assets

   When do i use it ?       Levered/Relevered beta is used when            Unlevered beta is used when calculati
                            calculating DCF using Enterprise approach i.e. using Equity approach i.e. from (FCFE)
                            from (FCF) - 'Free Cash Flows to Firm'         Cash Flows to Equity' approach

   Why ?                    Under Enterprise DCF approach cash flows            Under Equity DCF approach cash flow
                            for the firm are calculated (i.e. cash flows        equity are calculated (i.e. cash flows le
                            generated by assets, and not a particular type      equity shareholders alone). The paym
                            of capital). The payment to each capital            each capital provider is already made
                            provider shall be made from this and hence          hence the risk of leverage is already fa
                            when discounting this one must capture the          into the cash flows. When discounting
                            risk to be borne by residual providers as a         cannot consider the risk again and hen
                            result of financial leverage                        unlevered beta must be used. (i.e. bet
                                                                                risk of financial leverage)

   How do I calculate it ? It is also called as 'Raw' beta as we calculate it   Although academicians have come up
                           directly from market data without any other          over 15 methods of Unlevering and re
                           adjustment. There are 2 methods to do the            betas Practitioners use only one !
                           same - Covariance method and Regression.             BetaLevered = BetaUn-levered x (1 + D/E)
                           However, for Relevered beta academicians             Where, D/E is the Target Debt Equity r
                           suggest Unlevering Raw beta and then
                           relevering it to a theoretical concept called
                           'Target' capital structure. We suggest that
                           one assumes that the current capital
                           structure would be a fair proxy, as a company
                           will expand when it must from whatever
                           means of funding available
                       'Target' capital structure. We suggest that
                       one assumes that the current capital
                       structure would be a fair proxy, as a company
                       will expand when it must from whatever
                       means of funding available

What is Normalizing ? The beta thus calculated reflects historical performance alone! It is necessary to enco
                      some form of smoothing to reflect forecasted performance. Bloomberg came up wit
                      own smoothing formula what it calls 'Bloomberg Adjusted Beta'. Calculated as 2/3rd o
                      current calculated beta and 1/3rd of Long-term beta i.e. 1 (assuming that at some poin
                      future the company's beta will converge with broader market beta i.e. 1 !).E.g Raw be
                      Bloomber adjusted beta = (0.67 x 0.70) + (0.33 x 1) = 0.79.
                      We think it is better to have 2 betas. One used for discounting Explicit period cash flo
                      the other for continuing value. For the explicit period it is best to assume beta as norm
                      calculated while for continuing value one must consider the Long-term beta i.e. 1.
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 e risk of operations alone. i.e. risk
om fixed costs such as
n, rent & salaries. For this reason
 ed Asset beta - Risk related to
  of assets

 eta is used when calculating DCF
 approach i.e. from (FCFE) - 'Free
to Equity' approach

 y DCF approach cash flows for
alculated (i.e. cash flows left for
eholders alone). The payment to
  provider is already made and
 sk of leverage is already factored
h flows. When discounting one
 ider the risk again and hence
 eta must be used. (i.e. beta sans
 cial leverage)

ademicians have come up with
hods of Unlevering and relevering
tioners use only one !
= BetaUn-levered x (1 + D/E)
 s the Target Debt Equity ratio.
ne! It is necessary to encompass
 . Bloomberg came up with its
Beta'. Calculated as 2/3rd of
ssuming that at some point in
 et beta i.e. 1 !).E.g Raw beta 0.70

ng Explicit period cash flows and
est to assume beta as normally
 Long-term beta i.e. 1.
Calculating Raw Beta
        Sensex         Stock A
             0.09%        0.36%      0.0000621 =COVAR(C4:C24,D4:D24)
            -0.63%      -0.47%       0.0001383 =VAR(C4:C24)
              1.05%       -0.21%        0.45   =COVAR / VAR        =F4/F5
             -1.23%       0.64%
              1.48%       0.39%       0.4717     =SLOPE(D4:D24,C4:C24)
            -0.27%         -1.71%
             0.55%        0.02%
               1.81%        1.01%
                                                                        Stock A
            -0.32%        -1.43%                                2.00%
             0.39%         1.38%                                1.50%
             -1.38%      -0.32%
                                                                1.00%
             -1.28%      -0.53%
              1.84%        1.64%                                0.50%
             -1.37%       0.45%                                  0.00%
             0.20%       0.86%          -3.00%    -2.00%   -1.00%     0.00%   1.00%
               1.16%        1.24%                               -0.50%
             -1.55%        0.18%                               -1.00%
             -1.83%       -1.07%                               -1.50%
             0.79%           1.12%
             -1.47%        -1.41%                              -2.00%
             -0.17%        1.98%
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                                           Note: Data for beta calculation must be for a
                                           period of at least 3 years at monthly intervals
                                            or use average beta of a comparable set of
                                                              companies
          Regression using Market model


Stock A                 Beta = 0.4717
                         R² = 0.2806




                                 Stock A
    1.00%     2.00%    3.00%
Unlevering & Relevering

        Raw Beta / Levered beta / Equity beta                    1.3 << As calculated using regression or
        Current Debt-Equity                                     27% << Using Market value weights
        Target Debt-Equity                                      15% << Using Market value weights.
                                                                        Tip: It is best to look at the capita
        BU = BL / (1 + D/E)                                     1.02 << also known as operating beta i.e
        BRL = BU x (1 + D/E)                                    1.18 << Relevered based on 'Expected' o



                                      Impact of Target Debt on Relevered beta

                                                Target Debt/Equity
                               10%       15%         20%        25%         30%         35%
               1.18            1.13      1.18        1.23       1.28        1.33        1.38
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ulated using regression or Co-variance method from market data
Market value weights
Market value weights.
s best to look at the capital structures of mature companies in the same industry
own as operating beta i.e. as a result of fixed operating costs such as depreciation, rent and salaries
red based on 'Expected' or 'Estimated' Target Debt/Equity




                   40%
                   1.43

				
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posted:3/11/2012
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