Risk

• The dictionary meaning of risk is the

possibility of loss or injury; the degree or
probability of such loss.
• Any rational investor, before investing his or
her investible wealth in the stock, analyses the
risk associated with particular stock.
 Risk
• The actual return he receives from a stock
may vary from his expected return and the risk
is expressed in terms of variability of return.
 Risk
• Risk consisted of two components, the
systematic risk and unsystematic risk.
• Systematic risk is caused by factors external to
the particular company and uncontrollable by
the company.
• But unsystematic risk the factors are specific,
unique and related to the particular industry
or company.
 Systematic risk
• The systematic risk affects the entire market.
• Often we read in the newspaper that the stock
market is in the bear or bull.
• This indicates that the entire market is moving
in a particular direction either upward or
downward..
 Systematic risk
• The economic conditions, political situations
and the sociological changes affect the
security market.
• The recession in the economy affects the
profit prospect of the industry and the stock
market.
• These factors are beyond the control of the
corporate and the investor.
 Systematic risk
• Market risk
• Interest risk
• Purchasing power risk
 Systematic risk: market risk
• Jack Clark Francis has defined market risk as
that portion of total variability of return
caused by the forces of bull and bear markets.
• When the security index moves upward
haltingly for a significant period of time it is
known as bull market.
 Systematic risk: market risk
• Tangible risk: real events like earth quake, war,
political uncertainty and fall in the value of
currency.
• Intangible risk: events are related to market
psychology. Liberalization policy have an
positive impact on business.
 Systematic risk: Interest risk

• Interest risk is the variation in the single

period rates of return caused by the
fluctuations in the market interest rate.
• The fluctuations in the interest rates are
caused by the changes in the government
monetary policy and changes that occur in the
interest rates of treasury bills and the
government bonds.
 Systematic risk: Interest risk

• The bonds issued by the government and

quasi government are considered to be risk
free.
• If higher interest rates are offered, investor
would like to switch his investments from
private sector to public sector and vice versa.
 Systematic risk: Purchasing power risk

• Variations in the returns are caused also by the

loss of purchasing power of currency.
• Inflation is the reason behind the loss of
purchasing power.
• The level of inflation proceeds faster than the
increase in capital value.
• The rice in price penalizes the returns to the
investor and every potential rise I price is a risk
to the investor.
 Systematic risk: Purchasing power risk

• The inflation may be demand pull or cost push

inflation.
• In the demand pull inflation, the demand for
goods and services are in excess of their supply.
• At full employment level factors of production,
the economy would not be able to supply more
goods in the short run and demand for
products pushes the price upward.
 Systematic risk: Purchasing power risk

• The cost push inflation, as the name itself

indicates that the inflation or the rise in price
caused by the increase in cost.
 Unsystematic risk
• Unsystematic risk is unique and peculiarr to a
firm or an industry.
• Unsystematic risk is due to managerial
inefficiency, technological change in the
production process, availability of raw
material, changes in the consumer
preference, and labour problems.
 Unsystematic risk
• The changes in the consumer preference
effect the consumer products like television
sets, washing machines, refrigerators etc more
than they affect the consumer products.
 Unsystematic risk
• Business risk
• Financial risk
 Unsystematic risk: Business risk

• Business risk is that portion of the unsystematic

risk caused by the operating environment of the
business.
• It arises from the inability of a firm tom
maintain its competitive edge and the growth
or stability of the earnings.
• Variation that occurs in the operating
environment is reflected on the operating
income and expected dividends.
 Unsystematic risk: Business risk
• The variation in the expected operating
income indicates the business risk.
• For example take Anu and Vinu companies.
• Anu company operating income could grow
as much as 15 per cent and as low as 7 per
cent .
• Vine company, the operating income could
grow can be either 12 per cent or 9 per cent.
 Unsystematic risk: Business risk
• When both companies are compared, Anu
company’s business risk is higher because of
its high variability in operating income
compared to Vinu Company.
• Business risk can be divided into external
business risk and internal business risk
Unsystematic risk: internal Business risk

• internal business risk is associated with

operating efficiency of the firm.
• Fluctuations in the sales
• Research and development
• personnel management
• Fixed cost
• Single product
Unsystematic risk: internal Business risk

• Fluctuations in the sales: loss of customers

will lead to a loss in operational income.
• the company has to build a wide customer
base through various distribution channes
Unsystematic risk: internal Business risk

• Research and development: sometimes the

product may go out of style due to lack of
research and development.
Unsystematic risk: internal Business risk

• Personnel management: frequent strikes and

lock outs result in loss of production and high
fixed capital cost.
• the labor productivity also would suffer.
Unsystematic risk: internal Business risk

• Fixed cost: the cost components also generate

internal risk if the fixed cost is higher in the
cost component.
Unsystematic risk: internal Business risk

• Single product: the internal risk is higher in

the case of firm producing a single product.
 Unsystematic risk: External risk
• Social and regulatory factors.
• Political risk
• Business cycle
 Unsystematic risk: Financial risk
• It refers to the variability of the income to the
equity capital due to the debt capital.
• Financial risk in a company is associated with
capital strucutre of the company .
• Capital strucutre consists of equity funds and
borrowed funds.