Systematic Risks and Unsystematic Risks: Hi friends, Today I am going to share some interesting information on the topic of Systematic Risks and Unsystematic Risks.
Systematic Risk can be thought of as such as an event or circumstance of a loss. This is associated with the entire market or a segment there. The Unsystematic Risk is defined as the probability of a loss within a given industry or security.
Meaning and Components of Systematic Risks and Unsystematic Risks
This is the risk that makes the possibility of a collapse of the entire financial system or the stock market which is causing an involving effect on the entire system in the country. It is known to the risks caused by Financial system instability, Potentially catastrophic events to the joining, and other the dependence of two or more people in the overall market.
Example of Systematic Risk
Mr. A has made a collection of financial investments combining with 500 shares of a Media company, 500 Corporate bonds, and 500 Government bonds. The Central Bank has announced a current interest rate cut due to which Mr. A wants to rethink the effect on his portfolio and how he can re-work around it. Given that the Beta of the portfolio is 2.0, it is guessed that portfolio returns will be rising and falling irregularly in number 2.0 times more than the market returns.
If the market hikes by 3%, the portfolio will be increased by 3%*2.0 = 6%. On the other side, if the market falls by 3%, the overall portfolio will also decrease by 6%. Accordingly, Mr ‘A’ will have to lower the show of stocks and perhaps to increase exposure in bonds as the fluctuations are not sharp in the bonds compared to stocks.
The allocation of assets can be found 250 shares of Media company, 500 Corporate Bonds, and 750 Municipal bonds. It may seem to be used mode, but Municipal bonds are perhaps the most secure in terms of a default offering stable returns.
Generally, they reluctant to take risks. The investors will prefer a portfolio of beta less than 1 so that they have to become subject to lower losses in case of a sharp market decline. On the other hand, risk-takers will interests in securities with high betas aiming for higher returns.
The Uses of Systematic Risks are:
The other Governmental decision that having a widespread effect and Political instability.
- Economic crashes and change
- The Taxation laws have changes
- Natural Disasters
- Some Foreign Investment Policies
So, the Systematic risks are difficult to be serious since these are essential in nature and not necessarily controlled by a person or a group. There is no well-defined method for handling such risks. Still, as an Investor, one can found the fact of becoming more diverse into various securities to reduce the effect of individual situations, causing a ripple effect of such risks.
Unsystematic Risk is known as Varied or Non-systematic risk. it is the challenge related to certain security or a portfolio of securities. Investors are constructing these varied portfolios for allocating risks over different classes of assets.
The Example of Unsystematic Risk
On the year March 1, 2016, Mr. Matthew had invested $50,000 in a varied portfolio, which invests 50% in stocks of Automobile firms, 20% in I.T. stocks, and a balance of 30% in stocks of Airline companies. On the year of February 28, 2017, the value of the portfolio is increased to $57,500 thereby bringing an annual growth of 15%.
One fine day, he gets to know that one of the airlines has failed to fulfill an obligation on employee salary payments due to which the employees are on strike, and other airlines are expected to follow the same plan strategy.
The investor is worried and one option to be found for Mr. Matthew is to either hold on to the investment with the expectation of the issue is getting resolved or he can divert those funds to other sectors that are experiencing stability or maybe divert them in the bond investments.
The uses of Unsystematic Risks are:
- The Change of regulations affecting one industry
- The new entry of a competitor in the market
A company forced to recall one of its products that is the Galaxy Note 7 phone which is recalled by Samsung because of its battery turning flammable.
A firm has exposed to have made unjustifiably claiming activities with its financial statements like For instance, Satyam computers mislead their balance sheets.
An employee union strategy carefully planned to achieve a specific end for senior management to meet their demands.
The unsystematic Risks means the owner of a company’s securities is at risk of harmful changes in the value of those securities due to the risk that is caused by the company.
The field of operation is one of the options to reduce the effect, but it will still remain subject to the Systematic risk that affects the whole market. More is the diversification; lower will be the residual risk in the overall position.
So, the Unsystematic risk is measured and managed through the execution of various risk management tools, including the derivatives market. Investors can be aware of such risks, but different unknown types of risks can come up at any time, thereby increasing the level that causes one to feel uncertain.
This is exactly the meaning and its examples of Systematic and Unsystematic Risks. Here I have mentioned clearly the difference between systematic and unsystematic risks with the examples. Please go through the above-mentioned points and enjoy reading them.
If any Queries or Questions is persisting then, please feel free to comment on your viewpoints.
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