Systematic Risk

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Meaning and definition of systematic risk

Systematic risk refers to the risk intrinsic to the complete market or the complete market segment. Systematic risk is also sometimes referred as “market risk” or “un-diversifiable risk”. As explained by Investopedia, recession, wars, and interest rate represent the sources for systematic risk for they affect the complete market and are unavoidable through diversification. While this risk type affects a wide range of securities, unsystematic risk affects quite a particular group of securities or even an individual security. Moreover, systematic risk can be reduced by just being hedged.

Example of systematic risk

To illustrate systematic risk, let us take the example of an individual investor who purchases stock worth $10,000 I 10 biotechnology companies. If unexpected events lead to a appalling setback and one or more companies face a drop in the stock price, the investor experiences a loss. On the contrary, an investor purchasing stock worth $100,000 in a single biotechnology company would experience ten times the loss from such an event.

The second investor’s portfolio involves more unsystematic risk as compared to the diversified portfolio. As a final point, if the setback was aimed at affecting the complete industry instead, the investors would experience similar losses, resulting from systematic risk.

Sources of systematic risk

Systematic risk results from political factors, economic crashes, and recessions, changes in taxation, natural disasters, and foreign-investment policy. These risks are widespread as they can affect any investment or any organization.

Mitigating risk

Systematic risks are a little difficult to be mitigated. This is due to the reason that they are brought forth by the existing economic conditions or similar factors which are not in the control of the business management.

Identifying risk

Systematic risks are recognized by estimating and analyzing the statistical relationships between the different asset portfolios of an organization through the use of techniques like principal components analysis.

Risk handling

There is, however, no well defined method for handling systematic risks as they show impact on the entire market.

Investment decision

The decision of the investor on whether to reject or accept different investment options depends upon the risk type carried by the investment. In case of systematic risk like inflation, investors would like to invest in stable and less risky portfolio like a real estate. 

Quote Guest, 5 May, 2016
As an investor you must know the difference between systematic and unsystematic risk because it will help you to take effective investment decision. If you observer the investment decision of an investor, you can see that their investment decision is highly influenced by their risk taking behavior. Although future is uncertain, people always try to assume how much risk may arise in future if an investment is made.

Systematic RiskThe percent of risk which we cannot minimize or reduce through diversification is considered as systematic risk. This means that this type of risk is impossible to eliminate by an individual. It is directly related with the market, that’s why systematic risk also known as market risk. From my point of view systematic risk is arisen from the macro economic factors (inflation, unemployment rate, oil price etc.) which is beyond our control. Only through proper economic planning of government can reduce this types of risk. One important thing you need to know that although implementation of effective economic policies by government would reduce this type of risk but it needs time to be visible in the market. That’s why we cannot consider it when taking our individual investment decisions.

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