The difference between expected and realized return is called risk.
Probability of variation between Actual/Realized and Expected returns.
Types of Risks Systematic Risk Unsystematic Risk Systematic Risk The risk inherent to the entire market or an entire market segment. Also called undiversifiable risk, volatility or market risk, Affects the overall market, not just a particular stock or industry. Unpredictable and impossible to completely avoid. It cannot be mitigated through diversification, only through hedging or by using the right asset allocation strategy. Unsystematic Risk Company- or industry-specific hazard that is inherent in each investment. Also known as nonsystematic risk, "specific risk," "diversifiable risk" or "residual risk," Can be reduced through diversification. By owning stocks in different companies and in different industries, as well as by owning other types of securities such as Treasuries and municipal securities, investors will be less affected by an event or decision that has a strong impact on one company, industry or investment type. Examples a new competitor, a regulatory change, a management change and a product recall. Types of Systematic Risk Interest Rate Risk The changes in the interest rates As the interest rates goes up, the market prices of existing fixed income securities falls. For eg. A debenture has a face value of Rs.100 with a coupon rate of 10%. Now if the market rate of interest on the Security increases upto 12%, no investor will be ready to buy it. Hence, its value will decrease in secondary market by 2Rs. (it will sell at discount)
Market Risk Market Risk is consistent with the fluctuations seen in the trading prices of any particular share or security. 1. Boom or Low Period 2. Global Financial Crisis 3. Euphoria 4. Terrorist Attack 5. Political and Economic Disbalance 6. Investors Psychology Purchasing Power Risk/Inflationary Risk The risk that unexpected changes in consumer prices will penalize an investor's real return from holding an investment. Because investments from gold to bonds and stock are priced to include expected inflation rates, it is the unexpected changes that produce this risk. Fixed income securities, such as bonds and preferred stock, subject investors to the greatest amount of purchasing power risk since their payments are set at the time of issue and remain unchanged regardless of the inflation rate.
Types of Unsystematic Risk Unsystematic Risk Business Risk (Operational Leverage) Financial Risk (Financial Leverage) Business Risk The impact of the operating conditions is reflected in the costs of the company. The operating cost can be segregated into fixed costs and variable costs. A larger proportion of fixed cost is disadvantageous to a company. If the total revenue of such company declines due to some reasons or the other, there would be more proportionate decline in the operating profits because the company will not be able to recover its fixed costs. Such a company will face more of business risk. It simply means such company has high Operating Leverage. For eg. Taking factory plot on lease of 10 years for Rs. 12 Lac. In case if company has earned less operating revenue then it will not be able to recover its fixed cost. Financial Risk The presence of debt in the capital structure creates fixed payments in the form of payments of interest which is a compulsory payment they have to make whether the company suffers profits or losses. The fixed payment of interest creates more variability in Earning Per Share (EPS). If Rate of Return (Operating Profit) > Interest payable (Higher EPS) If Rate of Return (Operating Profit)< Interest Payable (Lower EPS) Such Risk is faced by the company which are highly Levered. Methods Of Measuring Risk Risk Unsystematic Risk Standard Deviation Variance systematic Risk Beta Regression Correlation