Difference between systematic and unsystematic risk

Difference between systematic and unsystematic risk

There is always a risk embedded in every investment such as stocks or bonds. The two main components of systematic risk and unsystematic risk, which when combined result in total risk. The systematic risk the result of external and uncontrollable variables, which are not specific to the sector or security and affect the entire market, causing the prices of all securities to fluctuate.

On the other hand, the unsystematic risk yes refers to the risk that emerges from controlled and known variables, which are specific to the sector or safety.

Systematic risk cannot be eliminated through portfolio diversification, while diversification is useful for avoiding unsystematic risks. Take a full reading of this article to learn about the differences between systematic and unsystematic risk.

Comparative chart

Basis for comparison Systematic risk Non-systematic risk
Sense Systematic risk refers to the danger associated with the market or the market segment as a whole. Unsystematic risk refers to the risk associated with a particular type of security, company or industry.
Nature Uncontrollable Controllable
factors External factors Internal factors
strikes Large number of titles on the market. Just a particular company.
types Interest risk, market risk and purchase risk. Corporate and financial risk
Protection Asset allocation Portfolio diversification

Definition of systematic risk

By the term "systematic risk" we mean the change in yields on securities, due to macroeconomic business factors such as social, political or economic factors. These fluctuations are related to changes in the performance of the entire market. The systematic risk caused by changes in government policy, by the act of nature such as natural disasters, changes in the national economy, international economic components, etc. The risk may entail a fall in the value of investments over a period. divided into three categories, which are explained as below:

  • Interest risk : risk caused by fluctuations in interest rates or interest from time to time and concerns interest-bearing securities such as bonds and bonds.
  • Inflation risk : alternatively known as purchase risk as it adversely affects an individual's purchasing power. This risk arises because of rising production costs, rising wages, etc.
  • Market risk : the risk affects the prices of a share, i.e. prices will rise or fall steadily over a period together with other market shares.

Definition of unsystematic risk

The risk arising from fluctuations in a company's security returns due to microeconomic factors, or factors existing in the organization, known as unsystematic risk. The factors causing this risk relate to a particular security of a company or sector, therefore they affect only a specific organization. The risk can be avoided by the organization if action is taken. been divided into two categories of business risk and financial risk, explained as below:

  • Business risk: the risk inherent in the securities that the company may or may not perform well. The risk when a company behaves below the average known as corporate risk. There are some factors that cause business risks such as changes in government policies, increased competition, changes in consumer taste and preferences, development of replacement products, technological changes, etc.
  • Financial risk : alternatively known as leveraged risk. When there is a change in the company's capital structure, it is a financial risk. The debt / capital ratio is the expression of this risk.

Key differences between systematic and unsystematic risk

The fundamental differences between systematic and non-systematic risk are provided in the following points:

  1. Systematic risk means the possibility of loss associated with the entire market or market segment. Non-systematic risk is defined as the risk associated with a particular sector or security.
  2. The uncontrollable systematic risk while the unsystematic controllable risk.
  3. Systematic risk arises from macroeconomic factors. On the other hand, unsystematic risk arises because of microeconomic factors.
  4. Systematic risk affects a large number of stocks on the market. Conversely, unsystematic risk affects the securities of a particular company.
  5. Systematic risk can be eliminated through various methods such as hedging, asset allocation, as opposed to unsystematic risk which can be eliminated through portfolio diversification.
  6. Systematic risk divided into three categories: interest risk, market risk and purchase risk. Unlike unsystematic risk, which is divided into two broad category corporate and financial risks.

Conclusion

Avoiding systematic and unsystematic risk is also a big task. Since external forces are involved in causing a systematic risk, they are therefore inevitable and uncontrollable. It also affects the entire market, but can be reduced through hedging and asset allocation. Because the unsystematic risk caused by internal factors so that it can be easily controlled and avoided, largely through portfolio diversification.