IAPM Assignment.pptx
- 1. SYSTEMATIC AND UNSYSTEMATIC RISK Presented by – Piyush Tanwar Preeti Roy Enrollment No.- 04013703921 04413703921 Presented to- Dr Geeta Mahajan
- 2. Concept Of Risk Risk in investment means that the future returns from that investment are unpredictable. The concept of risk may be defined as the possibility that the actual outcome (return) may not be same as expected.
- 4. Systematic Risk This part of the risk arises because every security has a built-in tendency to move in line with the fluctuations in the market. The systematic risk is also called the non-diversifiable risk or general risk. For e.g., if Government Bonds is offering a yield of 5% in comparison to the stock market which offers a minimum return of 10%. Suddenly, the government announces an additional tax burden of 1% on stock market transactions, this will be a systematic risk impacting all the stocks and may make the Government bonds more attractive.
- 5. Systematic Risk Interest Rate Risk Market Risk Purchasing Power/Inflationary Risk
- 6. Interest-Rate Risk • The interest rate risk to the variability in return caused by the change in level of interest rates. Such interest rate risk usually appears through the change in market price of fixed income securities, that is, bonds and debentures. • Security (bonds and debentures) prices have an inverse relationship with the level of interest rates.
- 8. 1. Price risk arises due to the possibility that the price of the shares, commodity, investment, etc. may decline or fall in the future. 2. Reinvestment rate risk results from fact that the interest or dividend earned from an investment can't be reinvested with the same rate of return as it was acquiring earlier.
- 9. Market Risk • Market prices of investments particularly equity shares may fluctuate widely within a short span of time even though the earnings of the company are not changing. • The market risk refers to variability in return due to change in market price of investment.
- 10. Market Risk Absolute Risk Relative Risk Directional Risk Non- Directional Risk Basis Risk Volatility Risk
- 11. 1. Absolute risk is without any content. For e.g., if a coin is tossed, there is fifty percentage chance of getting a head and vice- versa. 2. Relative risk is the assessment or evaluation of risk at different levels of business functions. For e.g. a relative-risk from a foreign exchange fluctuation may be higher if the maximum sales accounted by an organization are of export sales. 3. Directional risks are those risks where the loss arises from an exposure to the particular assets of a market. For e.g., an investor holding some shares experience a loss when the market price of those shares falls down. 4. Non-Directional risk arises where the method of trading is not consistently followed by the trader. For e.g., the dealer will buy and sell the share simultaneously to mitigate the risk 5. Basis risk is due to the possibility of loss arising from imperfectly matched risks. For e.g., the risks which are in offsetting positions in two related but non-identical markets. 6. Volatility risk is of a change in the price of securities as a result of changes in the volatility of a risk-factor. For e.g., it applies to the portfolios of derivative instruments, where the volatility of its underlying is a major influence of prices.
- 12. Purchasing Power Or Inflationary Risk • The inflation risk refers to the uncertainty of purchasing power of cash flows to be received out of investment. It shows the impact of inflation or deflation on the investment.
- 13. Purchasing Power/ Inflationary Risk Demand Inflation Risk Cost Inflation Risk
- 14. 1. Demand inflation risk arises due to increase in price, which result from an excess of demand over supply. It occurs when supply fails to cope with the demand and hence cannot expand anymore. In other words, demand inflation occurs when production factors are under maximum utilization. 2. Cost inflation risk arises due to sustained increase in the prices of goods and services. It is actually caused by higher production cost. A high cost of production inflates the final price of finished goods consumed by people.
- 15. Unsystematic Risk The unsystematic risk represents the fluctuations in return from an investment due to factors which are specific to the particular firm and not the market as a whole. The unsystematic risk results from random events. It is also called specific risk or diversifiable risk. For e.g., if the staff of the airline industry goes on an indefinite strike, then this will cause risk to the shares of the airline industry and fall in the prices of the stock impacting this industry.
- 17. Business Risk Business risk is also known as liquidity risk. It is so, since it emanates (originates) from the sale and purchase of securities affected by business cycles, technological changes, etc.
- 19. 1. Asset liquidity risk is due to losses arising from an inability to sell or pledge assets at, or near, their carrying value when needed. For e.g., assets sold at a lesser value than their book value. 2. Funding liquidity risk exists for not having access to the sufficient-funds to make a payment on time. For e.g., when commitments made to customers are not fulfilled as discussed in the SLA (service level agreements).
- 20. Financial Risk • Financial risk is also known as credit risk. • It arises due to change in the capital structure of the organization. The capital structure mainly comprises of three ways by which funds are sourced for the projects. • These are as follows: • 1. Owned funds. For e.g., share capital. • 2. Borrowed funds. For e.g., loan funds. • 3. Retained earnings. For e.g., reserve and surplus
- 21. Financial Risk/Credit Risk Exchange Rate Risk Recovery Rate Risk Sovereign Risk Settlement Risk
- 22. 1.Exchange rate risk is also called as exposure rate risk. It is a form of financial risk that arises from a potential change seen in the exchange rate of one country's currency in relation to another country's currency and vice-versa. For e.g., investors or businesses face it either when they have assets or operations across national borders, or if they have loans or borrowings in a foreign currency. 2. Recovery rate risk is an often-neglected aspect of a credit-risk analysis. The recovery rate is normally needed to be evaluated. For e.g., the expected recovery rate of the funds tendered (given) as a loan to the customers by banks, non-banking financial companies (NBFC), etc. 3. Sovereign risk is associated with the government. Here, a government is unable to meet its loan obligations, reneging (to break a promise) on loans it guarantees, etc. 4. Settlement risk exists when counterparty does not deliver a security or its value in cash as per the agreement of trade or business
- 23. • Operational risks are the business process risks failing due to human errors. This risk will change from industry to industry. It occurs due to breakdowns in the internal procedures, people, policies and systems.
- 24. Operational Risk Model Risk People Risk Legal Risk Political Risk
- 25. 1.Model risk is involved in using various models to value financial securities. It is due to probability of loss resulting from the weaknesses in the financial-model used in assessing and managing a risk. 2. People risk arises when people do not follow the organization’s procedures, practices and/or rules. That is, they deviate from their expected behavior. 3. Legal risk arises when parties are not lawfully competent to enter an agreement among themselves. Furthermore, this relates to the regulatory-risk, where a transaction could conflict with a government policy or particular legislation (law) might be amended in the future with retrospective effect. 4. Political risk occurs due to changes in government policies. Such changes may have an unfavorable impact on an investor. It is especially prevalent in the third-world countries.
- 26. One should keep in mind the below formula which highlights the importance of these 2 types of risks faced by all kinds of investors: Total Risk = Systematic risk + Unsystematic Risk
- 27. Captial Assets Pricing Model (CAPM) The CAPM attempts to explain and provide the mechanism whereby investors can assess the impact of a proposed security on their portfolio’s risk and return. The total risk of a portfolio can be bifurcated into systematic and unsystematic risk. The latter is eliminated by more and more diversification. On the other hand, the systematic risk is one which cannot be eliminated, and it correlated with that if the market portfolio.
- 28. • William Sharpe has suggested that the systematic risk can be measured by β, the beta factor. • The β can be viewed as an index of the degree of the responsiveness of the security’s returns with the market return. • The beta coefficient is the relative measure of sensitivity of an asset’s return to change in the return on the market portfolio.
- 29. Limitations of CAPM The calculation of beta factor is very tedious as lot of data is required. The beta factor can be found by examining the security’s historical returns relative to the return of the market portfolio. Further, the beta factor may or not reflect the future variability of returns. The beta cannot be expected to be constant over time. It must be updated frequently. The assumption of the CAPM are hypothetical and are impractical. For example, the assumption of borrowing and lending at the same rate is imaginary. In practice, the borrowing rates are higher than the lending rates. The required rate of return, RS , specified by the model can be viewed only as a rough approximation of the required rate of return.