Thread: Elements of Risk in a business

There are broadly 2 types of risks: Systematic & Unsystematic Risk

Systematic Risk: These are external risks which are uncontrollable and affect the entire economy or ecosystem collectively. Following are the types of Systematic Risk

1) Interest Rate Risk: Interest rates fixed by central banks affect debt securities like bonds & debentures. A change in interest rate has inverse relationship with the bond prices. All companies having debt on their books in form of bonds or debentures are exposed to this risk.

2) Market Risk: This risk is associated with a general bull or bear market. The effect of such risk is seen on all the stocks in bull or bear market. Eg: In march 2020, Share prices of major companies witnessed decline regardless of the sector they belonged to.

3) Inflation Risk: Inflation affects the purchasing power of money, This risk could be particularly high with investments in fixed income securities as the sudden higher inflation in economy can lead to negative real returns.

Unsystematic Risk: These risks are internal risks associated with the company. This risk affects the particular company due to internal vulnerability. Following are the types of Unsystematic Risk

1) Business Risk: A company is cyclical industry will have it's up cycles (Bullish) and down cycles (Bearish). This could affect the stock prices and investors returns depending upon the current cycle of the company.

2) Financial Risk: This risk arises due to change in capital structure of the company. A company having huge pile of debt may perform exceedingly well in it's up cycle but may end up bankrupt in the down cycle due to defaults on same debt. Leverage is a twin edged sword.

TIP: Systematic risks are the uncontrollable risks and one has to bear those. However, an investor can focus on Unsystematic risks that are company specific and try to minimize or mitigate them in order to generate sustainable returns.