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Types of Risk

In: Business and Management

Submitted By adwaitverma
Words 1612
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systematic risk and unsystematic risk
In finance, systematic risk, sometimes called market risk, aggregate risk, or undiversifiable risk, is the risk associated with aggregate market returns.
By contrast, unsystematic risk, sometimes called specific risk, idiosyncratic risk, residual risk, or diversifiable risk, is the company-specific or industry-specific risk in a portfolio, which is uncorrelated with aggregate market returns.
Unsystematic risk can be mitigated through diversification, and systematic risk can not be.[1]
Systematic risk should not be confused with systemic risk, the risk of loss from some catastrophic event that collapses the entire financial system. Contents [hide] * 1 Example * 2 Systematic risk and portfolio agement * 3 References * 4 See also |
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[edit]Example
For example, consider an individual investor who purchases $10,000 of stock in 10 biotechnology companies. If unforeseen events cause a catastrophic setback and one or two companies' stock prices drop, the investor incurs a loss. On the other hand, an investor who purchases $100,000 in a single biotechnology company would incur ten times the loss from such an event. The second investor's portfolio has more unsystematic risk than the diversified portfolio. Finally, if the setback were to affect the entire industry instead, the investors would incur similar losses, due to systematic risk.
Systematic Risk:
It is the risk which is due to the factors which are beyond the control of the people working in the market and that's why risk free rate of return in used to just compensate this type of risk in market.
Unsystematic Risk:
This is the risk other than systematic risk and which is due to the factors which are controllable by the people working in market and market risk premium is used to compensate this type of risk.…...

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