Systematic and Unsystematic Risk13/10/2022 0 By indiafreenotes
Systematic risk is caused by the changes in government policy, the act of nature such as natural disaster, changes in the nation’s economy, international economic components, etc. The risk may result in the fall of the value of investments over a period. It is divided into three categories that are explained as under:
- Interest risk: Risk caused by the fluctuation in the rate or interest from time to time and affects interest-bearing securities like bonds and debentures.
- Inflation risk: Alternatively known as purchasing power risk as it adversely affects the purchasing power of an individual. Such risk arises due to a rise in the cost of production, the rise in wages, etc.
- Market risk: The risk influences the prices of a share, i.e. the prices will rise or fall consistently over a period along with other shares of the market.
Unsystematic risk is the risk that is unique to a specific company or industry. It’s also known as nonsystematic risk, specific risk, diversifiable risk, or residual risk. In the context of an investment portfolio, unsystematic risk can be reduced through diversification while systematic risk is the risk that’s inherent in the market.
The risk can be avoided by the organization if necessary actions are taken in this regard. It has been divided into two category business risk and financial risk, explained as under:
- Business risk: Risk inherent to the securities, is the company may or may not perform well. The risk when a company performs below average is known as a business risk. There are some factors that cause business risks like changes in government policies, the rise in competition, change in consumer taste and preferences, development of substitute products, technological changes, etc.
- Financial risk: Alternatively known as leveraged risk. When there is a change in the capital structure of the company, it amounts to a financial risk. The debt–equity ratio is the expression of such risk.
|Meaning||Risk/Threat associated with the market or the segment as a whole||Hazard associated with specific security, firm, or industry|
|Controllability||Cannot be controlled||Controllable|
|Hedging||Allocation of the assets||Diversification of the Portfolio|
|Avoidance||Cannot be avoided||It can be avoided or resolved at a quicker pace.|
|Types||Interest Risk and Market Risk||Financial and Business risk|
|Impact||A large number of securities in the market||Restricted to the specific company or industry|
|Protection||Asset allocation||Portfolio diversification|