RISK

Size of the financial markets

How much is 1 Trillion Dollars in Indian
Rupees
• Suppose, US$ 1 = Rs. 68.73, It means one USD is equal to Rs. 68.73.
So, we have to multiply One Trillion American dollar with Rs. 68.73
• Example Calculation: US$1000, 000,000,000 x Rs. 68.73 = Rs.
68728950000000=
• Rs 68lakh crores
• Recent price is 73
India’s GDP 2016

• Nominal GDP is gross domestic product (GDP) evaluated at current market

prices, GDP being the monetary value of all the finished goods and services
produced within a country's borders in a specific time period

$2.29 trillion (nominal; 2016)

India's GDP
2.29 T US
dollars

Morgan
Stanley
Wealth
Management/
Assets under
management
2.05 trillion
USD
2014
The world financial markets(excluding FX) deal in $294 trillion in financial assets,
• The global capital market involves 46,000 traded stocks worth over $54 trillion.
• In 2012 the global bond market traded securities worth about $80 trillion, and
the mutual fund industry traded about $26.8 trillion globally.
• Exchange-traded funds traded securities worth $2 trillion globally in 2012, and
at the end of 2013
• the total notional amount of unregulated markets was about $710.2 trillion
globally
• US debt outstanding US treasury debt more than doubled from US$4.5tn in 2007
to US$11.9tn in 2013 - a large portion of which is held by foreign investors.
• The most important things in finance
• Valuation
• Risk
• LEVERED BETA VS UNLEVERED BETA
• Beta or levered beta is a measure of systematic risk of a firm in
relation to the market. Systematic risk is the risk which affects
the overall market. Beta does not take into account the
unsystematic risk. Unsystematic risk is the risk which
specifically affects a stock so it can be reduced by diversifying
the portfolio.
• Levered beta measures the risk of a firm with debt and equity
in its capital structure to the volatility of the market. The other
type of beta is known as unlevered beta. ... Comparing
companies' unlevered betas gives an investor clarity on the
composition of risk being assumed when purchasing the stock.
Risk components in levered Beta
Beta in the formula above is equity or levered beta which reflects the capital structure
of the company. The levered beta has two components of risk, business risk and
financial risk.
Business risk represents the uncertainty in the projection of the company’s cash flows
which leads to uncertainty in its operating profit and subsequently uncertainty in its
capital investment requirements.
Financial risk represents the additional risk placed on the common shareholders as a
result of the company’s decision to use debt, i.e. financial leverage.
If capital structure comprised of 100% equity then beta would only reflect business
risk. This beta would be unlevered as there is no debt in the capital structure. It is also
known as asset beta.
• Unlevered beta essentially neutralizes the effect of capital structure on a company’s
systematic risk exposure. It can be used to assess the ‘true’ systematic risk of a
company’s assets (not just equity). It follows from the Modigliani & Miller theories
 that cost of equity increases with increase in debt to equity ratio. The same applies to
a company’s equity beta. Due to higher debt, the risk of the company’s stock return’s
varying with reference to the market increases. It is useful to remove the systematic
risk that has creeped in due to exposure to debt. Unlevered beta is the measure of
systematic risk left after the additional financial risk resulting from debt is removed.
• Unlevered beta is an important input in the pure play method. The pure play method is
an approach to estimating cost of equity which involves unlevering the publicly-
available equity beta value of a comparable company using the comparable company
debt-to-equity ratio to get the unlevered (asset) beta which is then relevered using the
debt-to-equity ratio of the company under analysis.
• PURE PLAY METHOD
• Capital asset pricing model (CAPM) can be used for publicly
listed companies. Finding beta of projects or companies that are
not publicly listed is not possible through CAPM due to the lack
of data. Pure play method is used in such cases. Unlevered and
levered beta is used in this method to estimate the beta.
• Pure Play Method
• The pure play method is a calculation which takes a comparable but listed
company, and unlevers its beta (which means eliminating the effects of
financial leverage in its beta and relevering with the leverage the private
company has) to get the unlisted company’s risk quotient or beta. It can be
divided into following steps:
• 1. Find out a comparable company
• 2. Calculate the beta of the comparable company
• 3. Unlever the beta of the comparable company using the formula given
earlier
• 4. Relever the beta with the capital structure of the concerned company.
What is unlevered Beta?
Unlevered beta, also known as asset beta, is the beta of a company, after eliminating the effects of
financial leverage. It is also called asset beta because the risk is only due to its assets, as the debt
part is removed. Unlevered beta is often used for a company which is not publicly traded, using
the pure play method. Unlevered beta can be found out by removing the debt component from
the levered beta.
Levered Vs Unlevered Beta
Levered beta, or simply beta, calculates the systematic risk of a company with respect to the
market. Systematic risk is the risk that affects the whole market and is not confined to a specific
company or industry. Levered beta does not throw light on unsystematic risk, a risk confined to a
particular stock that can be mitigated by diversification. Levered beta focuses on the risk a
company has due to leverage.
Levered beta is not useful when comparing two companies with quite different capital structures.
In such a scenario, it is required that the debt effect is removed. This is done by “unlevering” the
beta, and the beta thus obtained is called unlevered beta.
• What type of risk do these measure
• Standard Deviation
• Beta
• Credit Spread
• Discount Rate: FCFF vs FCFE

• Just like valuation multiples differ depending on the type of cash flow being used, the discount rate in a DCF
also differs depending on whether Unlevered Free Cash Flows or Levered Free Cash Flows are being
discounted.

• If Unlevered Free Cash Flows are being used, the firm’s Weighted Average Cost of Capital (WACC) is used
as the discount rate because one must take into account the entire capital