BASIS FOR

SYSTEMATIC RISK UNSYSTEMATIC RISK

COMPARISON

Meaning Systematic risk refers to Unsystematic risk refers to

the hazard which is the risk associated with a
associated with the particular security,
market or market segment company or industry.
as a whole.

Nature Uncontrollable Controllable

Factors External factors Internal factors

Affects Large number of Only particular company.

securities in the market.

Types Interest risk, market risk Business risk and financial

and purchasing power risk
risk.

Protection Asset allocation Portfolio diversification

1.
2. Hybrid securities are investment instruments that combine the features of pure equities and pure
bonds. These securities tend to offer a higher return than pure fixed income securities such as bonds
but a lower return than pure variable income securities such as equities. They are considered less
risky than pure variable income securities such as equities but more risky than pure fixed income
securities.

Examples of Hybrid Securities

2.1. Preferred stocks

Holders of preferred stocks receive dividends before the holders of common stocks. Also, the dividend
received by the holders of preferred stocks is usually different from the dividend received by the holders
of common stocks. Preferred stocks are considered safer than common stocks but less safe than bonds.

2.2. In-kind toggle notes

In-kind toggle notes are a form of hybrid security that allows cash-strapped companies to raise
additional capital to meet short-term liquidity needs. An in-kind toggle note allows a company to pay
interest in the form of additional debt. The company issuing the in-kind toggle note gives the holder of
the note more debt in place of interest payment. In-kind toggle notes can be seen as an instrument to
delay the payment of interest to debtholders.

2.3. Convertible bonds

Convertible bonds are fixed income instruments with a call option on some equity. The convertible
bonds issued by a company can be converted into a fixed number of stock shares of that company. In
some special cases, a convertible bond issued by a company comes with a call option on the stocks of
some other company. These special convertible bonds are known as exchangeable bonds.

3. What Is a Derivative?

A derivative is a financial security with a value that is reliant upon or derived from, an underlying asset
or group of assets—a benchmark. The derivative itself is a contract between two or more parties, and
the derivative derives its price from fluctuations in the underlying asset.

Types of Derivatives

3.1. Forwards and futures

These are financial contracts that obligate the contracts’ buyers to purchase an asset at a pre-agreed
price on a specified future date. Both forwards and futures are essentially the same in their nature.
However, forwards are more flexible contracts because the parties can customize the underlying
commodity as well as the quantity of the commodity and the date of the transaction. On the other hand,
futures are standardized contracts that are traded on the exchanges.
 3.2. Options

Options provide the buyer of the contracts the right, but not the obligation, to purchase or sell the
underlying asset at a predetermined price. Based on the option type, the buyer can exercise the option
on the maturity date (European options) or on any date before the maturity (American options).

3.3. Swaps

Swaps are derivative contracts that allow the exchange of cash flows between two parties. The swaps
usually involve the exchange of a fixed cash flow for a floating cash flow. The most popular types of
swaps are interest rate swaps, commodity swaps, and currency swaps.

4.

 Interest rate Risk

 Market Risk
 Inflation Risk
 Business Risk
 Financial Risk
 Liquidity Risk
 Exchange rate Risk
 Country Risk

4.1. Interest rate Risk

Interest rate risk is referred to variability in returns of a security which result from changes in the level of
interest rates. Generally securities are inversely affected by such changes. This means that the price of
security moves inversely to the interest rate provided other things being equal. 

4.2. Market Risk

Market risk is considered as the variability in the returns as a consequence of fluctuations in the entire
market or aggregate stock market. Mostly common stock is more affected by market risk but all other
securities are also exposed to that risk.

4.3. Inflation Risk

The purchasing power risk is the factor that affects all the securities. It also refers as the likelihood that
the purchasing power of the invested dollars will fall. Even if the nominal return is safe, the real return
involves risk with uncertain inflation.

4.4. Business Risk

Business risk is the risk of conducting business in certain industry or environment.

 4.5. Financial Risk

The utilization of debt financing by companies includes the financial risk. When more assets of the
company are financed through debt then the variability in the return is enhanced provided other things
keep equal. Financial leverage is associated with the financial risk.

4.6. Liquidity Risk

The risk connected with certain secondary market in which there is trading of security is considered as
liquidity risk.