LOS e: Discuss beta estimation for public companies, thinly traded public companies, and nonpublic companies.

Q1. Adjusted beta for public companies compensates for:

A)   drift.

B)   leverage.

C)   changes in the market’s growth rate.

Q2. In the process of estimating beta for a private company, unlevering the beta calculated for the publicly traded comparable company accomplishes what goal?

A)   Establishing a baseline level of leverage.

B)   Improving the accuracy of the estimate in the event that the private company’s debt is of low quality.

C)   Isolating market risk.

Q3. There is a multistep process used to estimate the beta of nonpublic companies. What extra step must be taken to use the process on thinly traded public companies?

A)   Beta must be reduced using a liquidity factor.

B)   No extra step must be taken.

C)   Beta must be adjusted to reflect debt and equity levels.

LOS e: Discuss beta estimation for public companies, thinly traded public companies, and nonpublic companies. fficeffice" />

Q1. Adjusted beta for public companies compensates for:

A)   drift.

B)   leverage.

C)   changes in the market’s growth rate.

Correct answer is A)

An adjusted beta is a weighted average of the estimated beta and either 1.0 (the average for all stocks) or a peer mean (the beta of similar firms). The objective of an adjusted beta measure is to compensate for beta drift, or the tendency of beta to revert to 1.0 (or the industry average).

Q2. In the process of estimating beta for a private company, unlevering the beta calculated for the publicly traded comparable company accomplishes what goal?

A)   Establishing a baseline level of leverage.

B)   Improving the accuracy of the estimate in the event that the private company’s debt is of low quality.

C)   Isolating market risk.

Correct answer is C)

Market risk, also known as systematic risk, is the risk common to all assets within a certain class. Deleveraging the beta strips out the company-specific risk related to the target company’s leverage, thereby isolating market risk. Beta calculations do not require a baseline level of leverage. The equation for calculating beta for private companies assumes the company in question has high-grade debt. The deleveraging process will not help if the assumption is incorrect.

Q3. There is a multistep process used to estimate the beta of nonpublic companies. What extra step must be taken to use the process on thinly traded public companies?

A)   Beta must be reduced using a liquidity factor.

B)   No extra step must be taken.

C)   Beta must be adjusted to reflect debt and equity levels.

Correct answer is B)

The same procedure is used for both nonpublic and thinly traded public companies. Beta is adjusted to reflect debt and equity levels for both types of companies. The procedure for estimating beta for private or thinly traded public companies does not involve a liquidity factor.