Determinants of Beta

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Determinants of Beta

Beta for any entity is determined by considering the below 3 factors:

1) Type of Business:

Beta is a measure of the risk of a firm relative to a market index, the more sensitive business the higher is its beta. Eg. If any sector is very sensitive to economic conditions it will have a higher beta.

2) Degree of Operating Leverage:

The degree of operating leverage is a function of the cost structure of a firm, also known as the relationship between fixed cost and total cost. Higher variance in operating income will lead to higher beta for a firm with high operating leverage.

3) Degree of Financial Leverage:

An increase in financial leverage will increase the equity beta of a firm. Basically, Equity beta for a company is determined by both riskiness of the business it operates and the amount of financial leverage it has taken on.


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