Risks associated with Investments

Risk and uncertainty are an integral part of an investment decision. Technically, 'Risk' can be defined as a situation where the possible consequences of the decision that is to be taken are known. 'Uncertainty' is generally defined to apply to situations where the probabilities cannot be estimated. However, risk and uncertainty are used interchangeably.

The main focus contributing to risk are price and interest. Risk is also
influenced by external and internal considerations.

External risks are uncontrollable and broadly affect the investments. These external risks are called systematic risk. Risk due to internal environment of a firm or those affecting a particular industry are referred to as unsystematic risk.

Systematic Risk

Systematic Risk is non-diversifiable and is associated with the securities market as well as the

Economic (Sudden depression affects the demand for the products)

Sociological (Changes in the habit of the people, that affects the demand for particular product)

Political (When there is a change of new policies implemented by the government)

Legal considerations, (Suddenly nationalizing certain industries by the government) of the prices of all securities in the economy.

The effect of these factors is to put pressure on all securities in such a way that the prices of all stocks will move in the same direction. For example, during a boom period, prices of all securities will rise and indicate that the economy towards prosperity.

Unsystematic Risk

Unsystematic Risk is unique to a firm or industry. It does not affect an average investor. Unsystematic Risk is caused by factors like:

1) Labor Strike,

2) Irregular disorganized management policies and

3) Consumer Preferences.

These factors are independent of the price mechanism operating in the securities market.

Systematic and Unsystematic Risks can be further classified as follows:

Systematic Risk covers market risk, interest rate and Unsystematic Risk contains business and financial risks.

Every Industry and its shareholders face both systematic and unsystematic risk. Let us see these risk factors type in the next post.

Categories: Investment, Key Differences, Risk with Investments, Tutorials