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What is 'systematic & unsystematic risk' in sfm?

Dhiraj kumar (Employed) (427 Points)

26 November 2013

What is 'systematic & unsystematic risk' in SFM?

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Jithin (Learner) (1057 Points)
Replied 26 November 2013

Systematic risk refers to the risk which affects the whole stock market. For example, if, in the next year's budget, the tax rate for companies is increased, or long term capital gains exemption on equity shares u/s 10(38) is withdrawn, it will have an adverse effect on the share price of all the companies listed in the stock market. Same is the case if no political party gets majority in the elections next year. These types of risks cant be reduced by disposing one stock & buying another. The point is=> Its not possible to reduce systematic risk by diversification(by investing in shares in different companies or different sectors).

Unsystematic risk on the other hand is related to specfic companies or specific sectors. A company's stock price will be negatively impacted by accounting frauds, wrong management policies, declaration of below-par financial results, strike by the employees,etc. But this risk can be mitigated by selling the shares of that particular company & buying shares of another company which doesn’t pose the same level of risk. Similarly some risks are related to a particular sector. For example govt can make policies exclusively in relation to a specific sector. Stock prices of companies in that specific sector alone will be affected by the implementation of these policies. We can reduce these types of risks by investing in companies of different sectors,e.g.infrastructure,blue chip,textiles,banking & finance,etc. Thus unsystematic risk can be reduced through diversification.

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