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various kinds of Systematic and Unsystematic risk

various kinds of Systematic and Unsystematic risk

There are two types of Risk – Systematic (or non-diversifiable) and unsystematic(or diversifiable) relevant for investment – also, called as general and specific risk.
Types of Systematic Risk
1. Market risk: Even if the earning power of the corporate sector and the interest rate structure remain more or less uncharged prices of securities, equity shares in particular, tend to fluctuate. Major cause appears to be the changing psychology of the investors. The irrationality in the security markets may cause losses unrelated to the basic risks. These losses are the result of changes in the general tenor of the market and are called market risks.

various kinds of Systematic and Unsystematic risk

2. Interest Rate Risk: The change in the interest rate has a bearing on the welfare of the investors. As the interest rate goes up, the market price of existing fixed income securities falls and vice versa. This happens because the buyer of a fixed income security would not buy it at its par value or face value if its fixed interest rate is lower than the prevailing interest rate on a similar security.
3. Social or Regulatory Risk: The social or regulatory risk arises, where an otherwise profitable investment is impaired as a result of adverse legislation, harsh regulatory climate, or in extreme instance nationalization by a socialistic government.
4. Purchasing Power Risk: Inflation or rise in prices lead to rise in costs of production, lower margins, wage rises and profit squeezing etc. The return expected by investors will change due to change in real value of returns.

various kinds of Systematic and Unsystematic risk

Classification of Unsystematic Risk
1. Business Risk: As a holder of corporate securities (equity shares or debentures) one is exposed to the risk of poor business performance. This may be caused by a variety of factors like heightened competition, emergence of new technologies, development of substitute products, shifts in consumer preferences, inadequate supply of essential inputs, changes in governmental policies and so on. Often of course the principal factor may be inept and incompetent management.
2. Financial Risk: This relates to the method of financing, adopted by the company, high leverage leading to larger debt servicing problem or short term liquidity problems due to bad debts, delayed receivables and fall in current assets or rise in current liabilities.

various kinds of Systematic and Unsystematic risk

3. Default Risk: Default risk refers to the risk accruing from the fact that a borrower may not pay interest and/or principal on time. Except in the case of highly risky debt instrument, investors seem to be more concerned with the perceived risk of default rather than the actual occurrence of default. Even though the actual default may be highly unlikely, they believe that a change in the perceived default risk of a bond would have an immediate impact on its market price.

various kinds of Systematic and Unsystematic risk

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various kinds of Systematic and Unsystematic risk

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