-Notes of my Teacher.

 Risk & Uncertainty are an integral part of an

investment decision.
 Risk can be defined as a situation where the

possible consequences of the decision that is

to be taken are known.
 Uncertainty on the other hand is applied to

situation where the probabilities cannot be

estimated.
 Two components:
 Systematic Risk Market Risk
Interest Rate Risk
Purchasing Power Risk
 Unsystematic Risk Business Risk

Financial Risk
Features:
1. External to the company.
2. Uncontrollable.
3. Non-Diversifiable.
4. Associated with securities market.
5. Unavoidable.
6. Market moves in same direction upward or
downward.
 Portion of total variability of return which is
caused by the alternating forces of bull &
bear.
 More than 80% of securities prices rise or fall

along with the stock market indices.

 Tangible events: earth quack, war, political

uncertainty, post budget blurs.

 Intangible events: related to market

psychology.
 It is the variation in the single period rate of
return caused by the fluctuations in the
market interest rate.
 It affects the prices of bonds, debentures &

stocks.
 The fluctuations are caused by changes in

monetary policy & interest rate of treasury

bills.
 The rise or fall in interest rate affects the cost
of borrowing.
 The increase in the cost margin affect the

profitability of the traders. This would

dampen the sprits of the speculate traders
who use borrowed fund.
 Interest rate affect to corporate bodies who

carry their business with borrowed funds.

 Variations in the returns are caused by the
lose of purchasing power of currency.
 Inflation is the reason behind the loss of

purchasing power. Purchasing power risk is

also known as Inflation risk.
 It covers both inflation & deflation periods.
 Inflation in India has been either “cost push”

or “demand pull”.
 Demand pull Inflation: The demand for goods
& services are in excess of their supply. The
equilibrium between demand & supply is
attained at a higher price level.
 Cost Push Inflation: The increase in the cost

of raw material, labour, and equipment

makes the cost of production high and ends
in higher prices. It has spiraling effect on
price level.
 Unsystematic risk is that portion of total risk
which results from known and controllable
factors.
 It is caused due to factors unique or related

to a firm or industry.
 It can be reduced by diversification of

portfolio.
 It is caused by operating environment.
 It arises from inability of a firm to maintain

its competitive edge and the growth or

stability of earnings.
 The variations in expected operating income

indicates the business risk.

 Two types:

 Internal business risk

 External business risk
 Operational efficiency of firm.
1) Fluctuations in the sales
2) Research & Development
3) Personal Management
4) Fixed Cost
5) Single Product
 Result of imposed operating conditions.
1) Social & Regulatory Factors
2) Political Risk
3) Business Cycle
 It refers to the variability of the income to the
equity capital due to the debt capital.
 It is associated with capital structure of the

company. Capital structure is consist of

equity funds & borrowed funds.
 The debt financing increases the variability of

returns to the common stock holders and

affect their expectations regarding the return.
 As long as the earnings of a company are
higher than the cost of borrowed funds,
shareholders’ earning are increased. At the
same time when earnings are low, it may lead
to bankruptcy to equity holders.
 Financial Risk = EBIT – EBT
Every investor wants to guard himself from the
risk.
This can be done by understanding the nature
of risk & careful planning.
1) Market risk protection
2) Protection against Interest rate risk
3) Protection against Inflation
4) Protection against Business & Financial Risk
i. Study the price behavior of stock & history.
ii. The standard deviation & beta indicates the
volatility of the stock. NSE news bulletin.
iii. Should be prepared to hold the stock.
i. To hold the investment till maturity.
ii. The investor can buy treasury bills & bonds
of short maturity.
iii. To invest in bonds with different maturity
dates.
 The investor can diversify his investment in
real estate precious metals, arts & antique
along with the investment in securities.
i. Analyze the strength & weakness of the
industry.
ii. Analyzing the profitability trend to the
company. If there is inconsistency in the
earning it is better to avoid it.
iii. The financial risk should be minimized by
analyzing the capital structure of the
company. If debt equity ratio is higher, the
investor should have a sense of caution.