Question

CAPM is generally thought to take risk into account, but that is imprecise. It takes systematic risk into account, not total risk. Discuss the difference between systematic and unsystematic risks. Illustrate your discussion with current examples of risks (of both types).

Answer 1

Systematic risk: The risk which is associated with the entire market or the entire market segment is known as systematic risk. The systematic risk does not affect a specific stock, but all the companies in the market or segment.

Unsystematic risk: The risk which is peculiar to a specific company or industry is known as unsystematic risk.

Difference between systematic and unsystematic risk:

Serial No.	Basis of difference	Systematic risk	Unsystematic risk
1	Meaning	The systematic risk refers to the risk associated with the whole market or a specific segment.	The unsystematic risk is associated with an individual company or an industry.
2	Nature	The systematic risk is uncontrollable. The management of the company cannot diversify, minimize and eliminate the systematic risk.	The unsystematic risk is controllable. The management of the company can control the risk via portfolio diversification and upgrading management policies.
3	Sources	The systematic risk origins due to the external or macro-economic factors such as economic uncertainties, interest rate, inflation, recession wars and pandemic.	The unsystematic risk origins due to the internal or micro economic factors such as labor strike, new competitor, and decrease in demand.
4	Impact	The systematic risk affects the entire market or segment.	The unsystematic risk only affects a specific company or industry.
5	Control	The systematic risk occurs due to macro-economic factors which are uncontrollable in nature.	The unsystematic risk occurs due to internal factors. Therefore, the company can control them with the effective management policies.

Current scenario examples:

Systematic risk: COVID-19 pandemic is a reason for the systematic risk in the current market scenario. The pandemic has affected the entire global which affected in the production half in almost all industries. It has resulted in the decrease in the demand of many industries such as retail, automobile, electronics, gold, oil and gas. It has affected most of the company’s productivity. The remedy of the pandemic cannot be eliminated by the management policies. It depends on the development of a successful vaccine.

Unsystematic risk: American government has imposed a restriction on H1-B due to COVID-19 visa will lead to the tough time for the outsourcing companies such as Infosys and Wipro. The profitability of these companies will be compromised. However, these companies can minimize or control the risk by diversifying its resources.

Please take your valuable time and rate the solution as per your convenience.