systematic unsystematic risk

SYSTEMATIC & UNSYSTEMATIC RISK

SYSTEMATIC & UNSYSTEMATIC RISK

PRESENTER’S MAHARUKH HOZDAR

VAIBHAV THAKKAR

POOJA MEHTA

SANKET DOSHI

ANKIT SHAH

14PROF: Mr. KUNNADKARNI

SECURITY ANALYSIS PORTFOLIO MANAGEMENT

CONCEPT OF RISKCONCEPT OF RISK All investments are risky, whether in stock and capital

market or banking and financial sector, real estate, bullion,

gold, etc.

The degree of risk however varies on the basis of the

features other assets investment instruments, the mode of

Investment

Even the so called riskless assets like- bank deposits carry

some cost and time in realization of proceeds or in

conversion into cash

13-3

SYSTEMATIC RISK

• Risk factors that affect a large number of assets

• Also known as non-diversifiable risk or market risk

• Includes such things as changes in GDP, inflation,

interest rates, etc.

• It arises out of external and uncontrollable factors,

arising out of the market, nature of the industry and

state of economy and host of other factors.

Examples of systematic risk• Market risks• Interest rate risk• Purchasing power risk• The inflation rate increases.• The RBI promulgates a restrictive credit policy.• The government relaxes the foreign exchange

controls and announces full convertibility of Indian rupee.

• The government withdraw tax on dividend payments by companies.

13-5

UNSYSTEMATIC RISK

• Risk factors that affect a limited number of

assets

• Also known as unique risk and asset-specific

risk

• Includes such things as labor strikes, part

shortages, etc.

EXAMPLES OF UNSYSTEMATIC RISK• Business Risk• Financial Risk• Insolvency Risk• The company workers declare strike .• The company loses a big contract in a bid.• The company makes a break through in process

innovation.• The company is unable to obtain adequate

quantity of raw material.

13-7

RETURNS

• Total Return = expected return + unexpected return

• Unexpected return = systematic portion +

unsystematic portion

• Therefore, total return can be expressed as follows:

• Total Return = expected return + systematic portion +

unsystematic portion

13-8

TOTAL RISK

• Total risk = systematic risk + unsystematic risk

• The standard deviation of returns is a measure of

total risk

• For well-diversified portfolios, unsystematic risk is

very small

• Consequently, the total risk for a diversified portfolio

is essentially equivalent to the systematic risk

13-9

SYSTEMATIC RISK PRINCIPLE

• There is a reward for bearing risk

• There is not a reward for bearing risk unnecessarily

• The expected return on a risky asset depends only

on that asset’s systematic risk since unsystematic

risk can be diversified away

13-10

MEASURING SYSTEMATIC RISK• How do we measure systematic risk?

• We use the beta coefficient to measure systematic risk

• What does beta tell us?

• A beta of 1 implies the asset has the same systematic risk

as the overall market

• A beta < 1 implies the asset has less systematic risk than

the overall market

• A beta > 1 implies the asset has more systematic risk than

the overall market

13-11

TOTAL VERSUS SYSTEMATIC RISK

• Consider the following information: Standard Deviation Beta– Security C 20% 1.25– Security K 30% 0.95

• Which security has more total risk?• Which security has more systematic risk?• Which security should have the higher

expected return?

RISK: SYSTEMATIC AND UNSYSTEMATIC

Systematic Risk; m

Nonsystematic Risk;

n

Total risk; U

We can break down the risk, U, of holding a stock into two components: systematic risk and unsystematic risk:

risk icunsystemat theis

risk systematic theis

where

becomes

ε

m

εmRR

URR

SYSTEMATIC RISK AND BETAS• For example, suppose we have identified three

systematic risks on which we want to focus:1. Inflation2. GDP growth3. The dollar-euro spot exchange rate, S($,€)

• Our model is:

risk icunsystemat theis

beta rate exchangespot theis

beta GDP theis

betainflation theis

ε

β

β

β

εFβFβFβRR

εmRR

S

GDP

I

SSGDPGDPII

SYSTEMATIC RISK AND BETAS: EXAMPLE

• Suppose we have made the following estimates:1. I = -2.30

2. GDP = 1.50

3. S = 0.50.

• Finally, the firm was able to attract a “superstar” CEO and this unanticipated development contributes 1% to the return.

εFβFβFβRR SSGDPGDPII

%1ε

%150.050.130.2 SGDPI FFFRR

Systematic Risk and Betas: Example

We must decide what surprises took place in the systematic factors.

If it was the case that the inflation rate was expected to be by 3%, but in fact was 8% during the time period, then

FI = Surprise in the inflation rate

= actual – expected= 8% - 3%= 5%

%150.050.130.2 SGDPI FFFRR

%150.050.1%530.2 SGDP FFRR


If it was the case that the rate of GDP growth was expected to be 4%, but in fact was 1%, then

FGDP = Surprise in the rate of GDP growth

= actual – expected= 1% - 4%= -3%

%150.050.1%530.2 SGDP FFRR

%150.0%)3(50.1%530.2 SFRR


If it was the case that dollar-euro spot exchange rate, S($,€), was expected to increase by 10%, but in fact remained stable during the time period, then

FS = Surprise in the exchange rate

= actual – expected= 0% - 10%= -10%

%150.0%)3(50.1%530.2 SFRR

%1%)10(50.0%)3(50.1%530.2 RR

SYSTEMATIC RISK AND BETAS: EXAMPLE

Finally, if it was the case that the expected return on the stock was 8%, then

%150.0%)3(50.1%530.2 SFRR

%12

%1%)10(50.0%)3(50.1%530.2%8

R

R

%8R

SYSTEMATIC RISK AND BETAS• The beta coefficient, , tells us the response of the

stock’s return to a systematic risk.• In the CAPM, measures the responsiveness of a

security’s return to a specific risk factor, the return on the market portfolio.

13-20

DIVERSIFICATION

• Portfolio diversification is the investment in

several different asset classes or sectors

• Diversification is not just holding a lot of assets

• For example, if you own 50 “IT” stocks, you are

not diversified

• However, if you own 50 stocks that span 20

different industries, then you are diversified

13-21

THE PRINCIPLE OF DIVERSIFICATION

• Diversification can substantially reduce the variability of

returns without an equivalent reduction in expected returns

• This reduction in risk arises because worse than expected

returns from one asset are offset by better than expected

returns from another

• However, there is a minimum level of risk that cannot be

diversified away and that is the systematic portion

13-22

Figure 13.1

13-23

DIVERSIFIABLE RISK

• The risk that can be eliminated by combining assets

into a portfolio

• Often considered the same as unsystematic, unique

or asset-specific risk

• If we hold only one asset, or assets in the same

industry, then we are exposing ourselves to risk that

we could diversify away

Case Study

• Maharukh (working in SEBI) - Infosys

• Vaibhav (working in Kale Consultancy)- ICICI BANK

• Pooja (student) - COAL INDIA

• Sanket (student) – NITIN FIRE

• Ankit (working in Nomura holdings) - ADVISE

INFOSYS LTD

Thus there is fall in share price is 25.41% aprox

ICICI BANK LTD

Thus there is fall in share price is 16.16% aprox

COAL INDIA LTD

Thus there is rise in share price of17.54% aprox

NITIN FIRE LTD

Thus there is rise in share price of 45.53% aprox

EXPERTS ADVICE• By taking expert advise by an expert he made us invested in

various sectors and diversify the risk component.

• This will help mitigate the risk which is exposed by investing in

a single sector.

• Hedging your risk is also important part of diversifying your

risk.

• However, this can not guarantee that the value of a portfolio

won't fall in a market crash. But it certainly ensures that the

long-term goals of the investors will be met.

A DIVERSIFIED PORTFOLIOClients A portfolio as of AUGUST, 2011

2-Aug-11 Amount Stocks835 83,500.00 RIL483 48,300.00 HDFCBANK

1805.5 180,550.00 HERO HONDA397.1 39,710.00 COAL INDIA

1130.7 113,070.00 TCS432.05 43,205.00 BHARTI AIRTEL1733.7 173,370.00 LARSEN & TOUBRO

323.4 32,340.00 HUL227.85 22,785.00 DLF180.65 18,065.00 NTPC

Portfolio Value 754,895.00

• We have a BSE -SENSEX closing of 18110.00 point on

2nd August 2011

• We will compare the SENSEX gain/loss to the

gain/loss in the portfolio.

• The client A has a portfolio of about 7.55 lacs

• Lets see in the next slide’s how diversification helps

in mitigating risk & lowering the loss and also to earn

better profits.

• Clients A portfolio as of 26th AUGUST, 2011• The BSE-SENSEX CLOSED AT 15849

26-Aug-11 Amount Stocks722 72,200.00 RIL437 43,700.00 HDFCBANK

1955 195,500.00 HERO HONDA360.25 36,025.00 COAL INDIA949.25 94,925.00 TCS

400 40,000.00 BHARTI AIRTEL1529.7 152,970.00 LARSEN & TOUBRO319.05 31,905.00 HUL

175.7 17,570.00 DLF167.2 16,720.00 NTPC

Portfolio Value 701,515.00

COMPARISION & OBSERVATION• The BSE- SENSEX Closed at points 15849 which is

12.5 % down from August closing• The portfolio value has been down to Rs 701,515.00

and the fall in % terms is 7% this • We see that diversification helps in mitigating the

Risk.• We invested in different sectors of the companies

which were included in the Sensex, yet the Sensex got battered more than the portfolio

• Over diversification can also prove to be harmful.

THANK YOU

systematic unsystematic risk

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