Question

Explain what is meant by ‘systematic risk’ and ‘specific risk’. Give examples. (9 marks

Answer 1

Systematic risk.

- These risks are those which cannot be eliminated through diversification.

- These risks affect all the companies or industries in the economy.

- An investor is rewarded for bearing this risk.

Example:

-Govt policies

- Regulatory risk

- Tax policy

- Interest rate risk

- Foreign exchange fluctuation risk

- Stock market risk

- Political instability

- Purchasing power risk

Specific risk:

- These risks are those which can be eliminated through diversification

- These risks affects particular company or industry

Examples:

Death of a key managerial person

Non availability of raw material

Labour strike

Bussiness risk : heightened competition, emergence of new technologies, development of substitute products, shifts in consumer preference , inadequate supply of essential inputs.

Financial risk: high leverage leading to large debt servicing problems

Default risk : borrower may not pay interest and / or principal on time.