Systematic and Unsystematic Risk

Concept of Risk
 All investments are risky, whether in stock

and capital market or banking and financial
sector, real estate, bullion, gold, etc.
 The degree of risk however varies on the
basis of the features other assets,
investment instruments, the mode of
Investment
 Even the so called riskless assets like- bank
deposits carry some cost and time in
realisation of proceeds or in conversion into cash
RISK IN
FINANCE
SYSTEMATIC
UNSYSTEMATIC
RISK RISK
(Non- (Diversifiable)
diversifiable)
Can Diversification reduce all the risk of
securities?
 We just explained when two or more
securities are included in a portfolio, the
risk of individual securities in the portfolio
is reduced.
This risk totally vanishes when the number
of securities is very large.
While systematic risk is common to all
companies and has to be borne by
investor and compensated by the risk
premium,
Whereas the unsystematic risk can be
reduced by the investor through proper
diversification and planning a proper
investment strategy for the purpose.
Systematic Risk:-
 It is arise on account of the economy-wide
uncertainties and the tendency of
individual securities to move together
with changes in the market.
 It is also known as market risk.
 It is arise out of external and uncontrollable
factors, arising out of the market, nature of
the industry and state of economy and host of
other factors.
 These risk cannot be uncontrollable.
Examples of systematic risk
 Market risk:-
This arise out of changes in demand & supply pressures
in the market.
The totality of investor perception and subjective factors
influence the events in the market which are unpredictable
and not controllable.
 Interest Rate Risk:-
The return on investment depends on the interest rate
promised on it and changes in market rates of interest
from time to time.
This interest rates depends on nature of instrument,
stocks, bonds, etc. maturity of the periods and
creditworthiness of the issuer security.
 Purchasing power risk:-
Inflation or rise in prices lead to rise in
cost of production, lower margins, wage
rise etc.
The return expected by investor will
change due to change in real value of
returns.
Some other example of systematic risk
includes:-
 The government changes the interest rate
policy.
 The inflation rate increases.
 The RBI promulgates a restrictive credit
policy.
 The government relaxes the foreign
exchange controls and announces full
convertibility of Indian rupee.
 The government withdraw tax on dividend
payments by companies.
Unsystematic Risk:-
 It is arise from unique uncertainties of
individual securities. These uncertainties are
diversified if a large numbers of securities
are combined to form well-diversified
portfolios.
 It is also known as unique risk.
 It is arise out of known and controllable
factors, internal to the issuer of the
securities or companies.
 These risk can be controllable.
Examples of unsystematic risk:-
Business Risk:-
This relates to the variability of the business,
sales, income, profits etc. which in turn
depend on market condition for product mix
This risk sometime external to the company
due to changes in government policy, of
strategies of competitor.
Financial Risk:-
This relates to method of financing, adopted by
Company, delayed receivables and fall in current
assets
Insolvency Risk:-
The borrower may become insolvent or may
default, or delay the payments due, such as
interest instalments or principal repayments.
Borrower’s credit rating might have fallen
suddenly and he bacame insolvent
In such cases, the investor may get no return
or negative return.
Some other example of unsystematic risk
includes-
 The company workers declare strike .
 The R & D expert leaves the company.
 The company loses a big contract in a
bid.
 The company makes a break through in
process innovation.
 The company is unable to obtain
adequate quantity of raw material.

Systematic and Unsystematic Risk

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Systematic and Unsystematic Risk

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Concept of Risk

 All investments are risky, whether in stock

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