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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($,€)
• Our model is:
risk icunsystemat theis
beta rate exchangespot theis
beta GDP theis
betainflation theis
ε
β
β
β
εFβFβFβRR
εmRR
S
GDP
I
SSGDPGDPII
SYSTEMATIC RISK AND BETAS: EXAMPLE
• Suppose we have made the following estimates:1. I = -2.30
2. GDP = 1.50
3. S = 0.50.
• Finally, the firm was able to attract a “superstar” CEO and this unanticipated development contributes 1% to the return.
εFβFβFβRR SSGDPGDPII
%1ε
%150.050.130.2 SGDPI FFFRR
Systematic Risk and Betas: Example
We must decide what surprises took place in the systematic factors.
If it was the case that the inflation rate was expected to be by 3%, but in fact was 8% during the time period, then
FI = Surprise in the inflation rate
= actual – expected= 8% - 3%= 5%
%150.050.130.2 SGDPI FFFRR
%150.050.1%530.2 SGDP FFRR
Systematic Risk and Betas: Example
If it was the case that the rate of GDP growth was expected to be 4%, but in fact was 1%, then
FGDP = Surprise in the rate of GDP growth
= actual – expected= 1% - 4%= -3%
%150.050.1%530.2 SGDP FFRR
%150.0%)3(50.1%530.2 SFRR
Systematic Risk and Betas: Example
If it was the case that dollar-euro spot exchange rate, S($,€), 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