Introduction

➢ There is a positive relationship

between the amount of risk assumed
and the amount of expected return.
➢ Greater the risk, the larger the
expected return and larger and
changes of substantial loss.
➢ Investments which carry low risks
such as government securities will
offer a low expected rate of return
than those which carry high risk such
as equity stock of a new company.
➢ A rational investor would have some
degree of risk aversion he would
accept the risk only if he is adequately
compensated for it.
 What isRisk?

Riskis the variability betweenthe

expected and actual returns.
 Meaning

❑ The word risk has been derived from

Latin word ‘resecare’ which means ‘re’
means against and ‘secare’ means to
cut.

❑ It means to cut against or the part that

is cut off or lost. Thus risk is losing
something or suffering loss due to
future uncertainities.
 Definition
Risk may be defined as combination of
hazards measured by probability
-Irving Fisher

Friedman defined risk as catastrophe in

its latent form.

Bllokvist defined risk as the possible

loss of something of value.0
 Uncertainty
Risk refers to a situation where the
decision maker knows the possible
consequence of a decision and their
related likelihood.
Uncertainty involves a situation about
which the likelihood of outcome is not
known.
Uncertainty cannot be quantified
whereas risk can be quantified of the
likelihood of future outcomes.
 Risk VS Uncertainty
➢ A risk refers to a situation where there
is a possibility of loss.
➢ Uncertainty on the other hand refers
to a situation where the outcome is
not certain or is unknown.
➢ There is a lack of knowledge about
what will happen or may not happen.
➢ Uncertainty is just the opposite of
certainty where one is sure of the
outcome.
➢ Decision-making under uncertain
situations is difficult.
➢ It is the understanding of the
situation, skill, and judgment of the
decision-maker which helps in taking
decisions.
 Causes of Risk
➢ Wrong method of investment
➢ Wrong timing of investment
➢ Wrong quantity of investment
➢ Interest rate risk
➢ Nature of investment instruments
➢ Nature of industry in which the
company is operating.
➢ Creditworthiness of the issuer
➢ Maturity period or length of
investment
➢ Terms of lending
➢ National and international factors
➢ Natural calamities etc.
 Types of Risk

Systematic Unsystematic
risk risk

Interest rate Purchasing

Market risk Business risk
risk power risk

Financial risk

Credit or
default risk

Other risks
 Systematic risk
➢ It refers to that portion of variation in
return caused by factors that affect
the price of all securities.
➢ The effect in systematic return causes
the prices of all individual securities
to move in the same direction.
➢ The movement in generally due to the
response to economic, social and
political changes.
➢ The systematic risk cannot be
eliminated by the diversification of
portfolio, because every share, bond
is influenced by the general market
trend.
 Market Risk

➢ Market Risk refers to the variability in returns

resulting from fluctuations in the overall
market conditions.
➢ It arises out of changes in demand and supply
pressures in the market following the changing
flow of news or expectations.
➢ Apart from this the subjective factors like
psychology and sentiments of investors also
cause some market fluctuations and
uncontrollable risk.
 Interest Rate Risk
It is the risk that an
investment’s value will
change as a result of
change in interest
rates. This risk affects
the value of bonds
more directly than
stocks.
Basically the monetary and
credit policy which is not
controllable by the investor
affects the riskiness of the
investments due to their
effects on returns
expectations and the total
principal amount due to be
refunded
 Purchasing Power risk
➢ Uncertainty of purchasing power is
referred to as risk due to inflation.
➢ Inflation arouses optimism since the
entire prices go up and that lead to
higher incomes.
➢ Cost Push inflation
➢ Demand pull inflation
➢ Purchasing power risk is the
uncertainty of the purchasing power
of the amounts to be received in
future due to both inflation and
deflation.
 Unsystematic Risk

➢ It refers to that portion of risk which is

caused due to factors unique or
related to a firm or industry.
➢ This risk is a company specific risk
and can be controlled if proper
measures are taken.
➢ As it is unique to a particular firm or
industry it is caused by factors like
labour unrest, management policies,
shortage of power, recession in a
particular industry, consumer
preferences etc.
 Business Risk
• It can be internal as well as external.
• internal risk is caused due to
improper product mix, non-availability
of raw materials, incompetence to
face competition etc.
• External business risk arises due to
change in operating conditions
caused by conditions thrust upon the
firm which are beyond its controls,
changes in business laws,
international market conditions etc.
 Financial risk
• It is associated with the capital
structure of the company.
• A company with no debt financing has
no financial risk.
• The extent of financial risk depends
on the leverage of the firm’s capital
structure.
 Credit or Default risk

• It deal with the probability of meeting

a default.
• It is primarily the probability that a
buyer will default.
• The chances that the borrower will not
pay can stem from a variety of factors.
• Proper management of credit risk
reduces the chances of non-payment
of loan by the borrowers and involves
exploration by the company of ways
and means of encouraging prompt
payment.
 Other Risk
When investing in foreign countries one must consider
the fact that currency exchange rates can change the
price of the asset as well. This risk applies to all financial
instruments that are in a currency other than your
domestic currency.
Other classifications of Risks
1. Individual and group risks

• If a risk affects the economy or its

participants on macro basis.
• It is a group risk.
• These risks affect most of segments
of the society.
• These risks may be unemployment,
war, floods, earthquake etc.
• Individual risks are confined to
individual industries or small groups.
• The risks such as fire, theft, robbery
etc. are individual risks.
 2. Financial and Non-
Financial Risks
➢ Financial risks are those when a
person stands to loss or is adversely
affected by some event or there is
some type of loss or some occurrence
may expose assets or property to
financial loss.

➢ When there is no possibility of

financial loss, these are non-financial
risks.
3. Pure and Speculative Risks
➢ Pure risks are those situations where
possibility of loss or may or may not
be there.
➢ If such a risk is insured and loss
arises then insurance company will
compensate the loss.
➢ Speculative risks are those risk where
there is possibility of profit or loss.
➢ These risks ae undertaken with the
intention of earning a profit but
possibility of loss also remains.
➢ Pure risks have a possibility of
avoiding loss only whereas
speculative risks have the possibility
of gain also.
4. Static and Dynamic Risks
➢ Dynamic risks are those which are the
outcome of changes in economy or
the environment.
➢ These risks mainly refer to the macro
economic variables like inflation,
income and output levels,
technological changes etc.
➢ Dynamic risks emanate from the
economic environment so these may
not be anticipated or quantified.
➢ Static risks are more or less
predictable and are not affected by
economic environment.
➢ These risks are similar to pure risks
and are suitable for insurance.
 5. Quantifiable and Non-
Quantifiable risks

➢ The risks which can be measured like

financial risks are quantifiable risks.
➢ Those risks which may result in
situations like tensions, loss of peace
etc are non quantifiable.