Risk is considered as inevitable in the securities because there is possibility that realized returns of securities will be less than the returns expected. There are various factors that contribute to variations in expected returns, these forces are termed as elements of risk. The risk associated with the investments can be broadly divided into systematic and unsystematic risk.
The external factors that cannot be controlled and broad in their effect constitute sysytematic risk. Systematic risk caused by the economic, sociological and political changes in the country. Systematic risk is a risk which is caused by the external forces and cannot be controlled by the management of the firm. This type of risk affects large number of securities.
SOURCES OF SYSTEMATIC RISK
There are some important factors that result in systematic risk, they are as follows.
1. MARKET RISK
Variability in return on most common stocks that is due to basic changes in the investor expectation is called as markret risk. The prices of stock may fluctuate widely within a short span of time, which results in market risk.
2. INTEREST-RATE RISK
The change in the interest rates because of the fluctuations in the demand and expectations of the performance of the stocks in future is called as a interest-rate risk.
3. PURCHASING POWER RISK
The risk which occurs when there is an uncertainity of the purchasing power of the money to be recieved, i.e. the inflation or deflation of the investment.
The internal factors of the firm which can be controlled to a large extent constitute unsystematic risk. The portion of the total risk that is unique to a firm or industry is called as unsystematic risk. For example, factors such as labour strikes, management capabilities, marketing of products, etc.cause unsystematic risk.
The unsystematic risk factors are lagely independent of factors affecting scurities market in general. Because these factors affect one firm, they msut be examined for each firm.
SOURCES OF UNSYSTEMATIC RISK
There are many factors that affects the firm which constitutes unsystematic risk, they are as follows.
1. BUSINESS RISK
The risk which is associated with the firm, because of the variability of sales, income, profits, etc. which are caused due to fall in production, labour problems, raw material problems, etc.
2. FINANCIAL RISK
The risk which occurs because of the methods of financing used by the firm like equity, debt, etc. short-term liquidity problems due to bad-debts, etc also result in financial risk.
3. INSOLVENCY RISK
The borrower of funds may become insolvent or may default. This risk is termed as insolvency risk caused because of firms decisions.
There exists many differences between systematic risk and unsystematic risk. some of them are represented in table below.
SYSTEMATIC RISKUNSYSTEMATIC RISKSystematic risk is external and uncontrollable by the firm.Unsystematic risk is internal and controlled by the firm. NATURESystematic risk is the risk which is non-diversifiable.Unsystematic risk is the risk which can be diversified. SOURCESSources of systematic risk are market risk, purchasing power risk, interest rate risk, etc.Sources of Unsystematic risk are financial risk, business risk, insolvency risk of the firm.
There are many other risks which can be listed out in systematic risk and unsystematic risk. Some of them are political risk, management risk, liquidity risk, etc. these are the risks which adversely effect the investment decisions.