Professional Documents
Culture Documents
Hedging - purchasing/selling a
financial instrument specifically to
reduce or cancel out the risk in
another investment
Speculation - increasing measurable
risk and exposing the investor to
catastrophic (disastrous) loss in
pursuit of very high windfalls (bonus)
that increase expected value.
Systematic Risk
The risk inherent tothe entire market or entire
market segment. Also known as "undiversifiablerisk" or "market risk."
Interest
rates,
recession
and
wars
all
representsources of systematic risk because they
affect the entire market and cannot be avoided
through diversification.
This type of risk affects a broad range of securities.
Unsystematic risk affects a very specific group of
securities or an individual security.
Systematic risk can be mitigated only by being
hedged. Even a portfolio of well-diversified assets
cannot escape all risk.
1. Market Risk:
Market risk is referred to as stock / security variability
due to changes in investors reaction towards tangible
& intangible events
It is the chief cause affecting market risk. The first set
that is the tangible events, has a real basis but the
intangible events are based on psychological basis.
Real Events, comprising of political, social or Economic
reason. Intangible Events are related to psychology of
investors or say emotional intangibility of investors.
The initial decline or rise in market price will create
emotional instability of investors & cause a fear of loss
or create an undue confidence, relating possibility of
profit. The reaction to loss will reduce selling &
purchasing prices down & the reaction to gain will
bring in the activity of active buying of securities.
1. Business Risk:
Business risk arises due to uncertainty of return
which depend upon the nature of business. It relates
to variability of business, sales, income, expenses &
profits. It depends upon market conditions for the
product mix, input supplies, strength of competitor
etc. Business risk may be classified into two kind viz.
Internal Risk and External risk.
Internal risk is related to operating efficiency of
firm. This is manageable by the firm. Interest
Business risk leads to fall in revenue & profit of the
companies.
External risk refers to policies of government or
strategic of competitors or unforeseen situation in
market. This risk may not be controlled & corrected
by the firm.
2. Financial Risk:
It is associated with the way in which a company finances its
activities. Generally, financial risk is related to capital
structure of a firm. Presence of borrowed money or debt in
capital structure creates fixed payments in the form of
interest that must be sustained by the firm. Presence of these
interest commitments fixed interest payments due to debt
or fixed dividend payments on preference share causes
amount of retained earning availability for equity share
dividends to be more variable than if no interest payments
were required. Financial risk is avoidable risk to the extent
that management has the freedom to decline to borrow or not
to borrow funds. A firm with no debt financing has no financial
risk. One positive point for using debt instruments is that it
provides a low cost source of funds to a company at the same
time providing financial leverage for the equity shareholders
& as long as the earning of company are higher than cost of
borrowed funds, the earning per share of equity share are
increased.