Question

1. How does the industry impact a company’s risk? Would the risk associated with the industry/company you selected influence your decision to invest? Explain.

Answer 1

Industry specific risk is an important consideration while evaluating the company risk. Company risk is directly proportional to its industry risk. If the industry is expected to perform well in which the company is operating, it's a good and positive sign for the company as well. Few points how the industry impact a company's risk is given below:-

- Competition - If there is intense amount of competition present within the industry, the companies would be going all out with the quality, prices, advertisement, etc. to lure the customers. Such cutthroat competition can affect the margins and thus increases the risk in future.

- Industry wide regulations - If there are any regulation imposed by the Government which affects the industry as a whole adversely then the companies are affected too. Such regulations are sometimes harsh and may even challenge the survival of small organizations thus increasing the overall risk. For example, the recent carbon emission law imposed by various governments all over the world on their respective auto industry has impacted the margins of the auto companies.

Yes, the risk associated with the industry/company we select would surely influence our decision to invest. A risk adverse investor would not invest in industries/companies with higher beta. Similarly, a risk taking investor would look for opportunities in the companies/industries which provide them with high return opportunity thus, increasing the risk of investment. A passive investor would try to replicate the industry benchmark stock using the same components and weights whereas an active investor would want to deviate from these rules.