Risk

10/6/16

Ekta Singh (NBS, GREATER NOIDA)

Chapter Objectives
To understand the concept of risk
To know the various types of risk
To comprehend the tools of
measuring the risk

10/6/16

Ekta Singh (NBS, GREATER NOIDA)

Concept of Risk
Risk is expressed in terms of
variability of return.
An investor before investing in
securities must properly analyze the
risks associated with these
securities.
There are two types of risks:
Systematic risk
Unsystematic risk
10/6/16

Ekta Singh (NBS, GREATER NOIDA)

Systematic Risk
It is the risk that is caused by
external factors such as economic,
political and sociological conditions.
It affects the functioning of the entire
market.
They are of three types:
Market risk
Interest rate risk
Purchasing power risk
10/6/16

Ekta Singh (NBS, GREATER NOIDA)

Market Risk
When the stock market moves upwards, it is
known as bull market. On the other hand,
when the stock market moves downwards,
then it is known as bear market.
The two forces that affect the market are:
Tangible events: Earthquake, war,
political uncertainty and decrease in the
value of money are some of the examples
of tangible events.
Intangible events: It is related to market
psychology. Political unrest or fall of
government affects the market sentiments.
10/6/16

Ekta Singh (NBS, GREATER NOIDA)

Interest Rate Risk

It is the risk caused by the variations in the
market interest rates.
Prices of debentures, bonds, etc. are mainly
affected by the interest rate risk.
The causes of interest rate risk are as follows:
Changes in the governments monetary
policy
Changes in the interest rate of treasury
bills
Changes in the interest rate of government
bonds
10/6/16

Ekta Singh (NBS, GREATER NOIDA)

Purchasing Power Risk

Variations in returns are caused by
the loss of purchasing power of
currency.
There are mainly two types of
inflation:
Demand-pull inflation: The demand
for goods and services remains higher
than the supply.
Nominal future value
Cost-push inflation:
There
1.0 Inflation
Rate is a rise in
price due to the increase
in the cost of
1.0 r
1.0
production.
1.0 IR
Real future value
Ekta Singh =
(NBS, GREATER NOIDA)

10/6/16

Unsystematic Risk
It is a type of risk which is unique,
specific and related to a particular
industry.
Managerial inefficiency, changes in
preferences of the consumers,
availability of raw material, labour
problems, etc. are some of the
causes of unsystematic risk.
These are of two types:
Business risk
10/6/16
Ekta Singh (NBS, GREATER NOIDA)
Financial risk

Business Risk
It is the risk that is caused by the
inefficiency of a company to manage its
growth or stability of earnings.
It can be classified as:
Internal business risk: It is the risk that is
associated with the operational efficiency of a
company.
External business risk: It is the risk that is
the result of operating conditions imposed on
the firm by the external environment.
10/6/16

Ekta Singh (NBS, GREATER NOIDA)

Financial Risk
It is associated with the capital structure of
the company, which consists of equity and
borrowed funds.
A financial risk can be avoided by
analyzing the capital structure of the
company.
The financial risk considers the risk
between EBIT and EBT.
The payment of interest affects the
eventual earnings of the company.
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Ekta Singh (NBS, GREATER NOIDA)

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Risk Measurement
An efficient measurement of risks provides an
appropriate quantification of risk.
Standard deviation is used as a tool for
measuring the risk, which is a measure of the
variables around its mean.
The following formula is used to calculate
standard deviation:
N

P r -E(r)

i=1

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Ekta Singh (NBS, GREATER NOIDA)

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Beta
v

Beta describes the relationship between the

stock return and index return.

Beta = +1.0. One per cent change in index

return causes one per cent change in stock
return.

Beta = +0.5. One per cent change in index

return causes 0.5 per cent change in stock
return.

Negative beta indicates that the stock return

and the market move in opposite directions.

10/6/16

Ekta Singh (NBS, GREATER NOIDA)

12

Expected Return
The expected return of the
investment is the probability
weighted average of all the possible
returns.
It is the sum of the products of
possible returns with their respective
probabilities.

10/6/16

Ekta Singh (NBS, GREATER NOIDA)

13

Chapter Summary
By now, you should have:
Understood the concept of risk
Learnt about the types of risks
Comprehended the tools for measuring the
risk

10/6/16

Ekta Singh (NBS, GREATER NOIDA)

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