Risk and types of risk measurement of risk

Risk and return

1. Unit-4 Mutual Fund III BBA Investment Management Risk and Types of Risk Mangalore University syllabus (lecture -8) GEETHA. S Assts.Professor of Management Studies Government First Grade College – Punjalakatte Email : [email protected]

2. Risk Meaning The dictionary meaning of risk is the possibility of loss or injury. The degree or probability of such loss. In risk, the probable outcomes of all the possible events are listed In other words , the existence of volality in the occurrence of an expected event is called risk.

3. Risk Risk in investment analysis means that the future returns from an investment are unpredictable. Risk refers to the chance that the actual outcome(return) from an investment will differ from the expected outcome. Presence of risk means that more than one outcomes are possible. The risk may be considered as a chance of variation in return. Investment having greater chances of variations are considered more risky than those with lesser chances of variations.

4. Types of Risk Systematic Risk 1. Inflation Risk 2. Crude oil Prices 3.Extenral value of the rupee 4. Interest Risk 5. Market Risk Unsystematic Risk 1. B usiness Risk 2.Technology Risk 3. Financial Risk 4. Contractual Default Risk

5. Systematic Risk Systematic risk refers to that portion of the variability in return which is caused by the factors affecting all the firms. It refers to fluctuation in return due to general factors in the market such as money supply , inflation, economic recessions, interest rate policy of the government, political factors , credit policy tax reforms etc. Types of S ystematic Risk Inflation Rate Risk Crude oil prices External value of the rupee Market risk

6. Types of Systematic Risk Inflation Risk Variations in the returns are caused also by the loss of purchasing power of currency. Inflation, is the reason behind the loss of purchasing power. The level of inflation proceeds faster than the increase in capital value. Purchasing power risk is possible loss in the purchasing power of the returns to be received. The rise in price penalizes the returns to the investor, and every potential rise in price is a risk to the investor.

7. Types of Systematic Risk Crude Oil Prices The prices of crude oil affect the market sentiment very quickly. The whole of economy depends upon the price of crude oil , as the main products and bi-products are used by hundreds of industries directly and indirectly. Continuously increasing the price of crude oil make the transportation costlier. This increase the distribution cost of all the commodities in the economy including essential commodities.

8. Types of Systematic Risk Interest R ate Risk Interest rate risk is the variation in the single period rates of return caused by the fluctuations in the market interest rate. The fluctuations in the interest rates are caused by the changes in the government monetary policy and changes that occur in the interest rate of treasury bills and the government bonds. The bonds issued by the government and quai - government are considered to be risk free. It higher interest rates are offered, investor would like to switch his investments from private sector bonds to public sector bonds. Likewise, if the stock market is in a depressed condition, investor would like to shift their money to the bond market, to have an assured rate of return.

9. Types of Systematic Risk Market Risk Jack Clark Francis has defined market risk as that portion of total variability of return caused by the alternating forces of bull and bear markets. When the security index moves upward haltingly for a significant period of time it is known as bull market. Bear market is just a reverse to the bull market. The forces affect the market are tangible and intangible events. Tangible events are real events like earthquake, war, political uncertainty, and fall in the value of currency. Intangible events are related to market psychology. The market psychology is affected by the real event. But reactions to the tangible events become over reactions and they push the market in a particular direction. This type of over reaction affects the market adversely and the prices of the scrip's fall below their intrinsic values. This is beyond the control of the corporate.

10. Unsystematic Risk Unsystematic risk represents the fluctuations in return from an investment due to factors which are specific to the particular firm and not the market as a whole. These factors may also be called firm specific and affect one firm without affecting other firms. For example , a fluctuation in the price of crude oil will effects the fortune of petroleum companies but not the textile manufacturing company. As the unsystematic risk results from random events that tend to be unique to an industry or a firm, this risk is random in nature. Unsystematic risk is also called specific risk or diversifiable risk.

11. Types of Systematic Risk 1. Business Risk 2. Financial Risk

12. Types of Systematic Risk Business Risk Business risk is that portion of the unsystematic risk caused by the operating environment of the business. Business risk arises from the inability of firm to maintain its competitive edge and growth or stability of the earnings. Variations that occurs in the operating environment is reflected on the operating income and expected dividends. The variation in the expected operating income indicates the business risk. Internal Business Risk External Business Risk

13. Types of Systematic Risk Internal B usiness Risk Fluctuations in the sales Research and Development ( R & D) Personnel Management Fixed Cost Single Product

14. Types of Systematic Risk External Business Risk Social and Regulatory factors Political Risk Business Cycle.

15. Types of Systematic Risk 2. Financial Risk It refers to the variability of the income to the equity capital due to the debt capital. The debt financing increases the variability of the returns to the common stock holders and affect their expectations regarding the return. Debt financing enable the corporate to have funds at a low cost and financial leverage to the share holders. As long as the earnings of a company are higher than the cost of borrowed funds, shareholder’s earnings are increased. At the same time when the earnings are low, it may lead to bankruptcy to equity holders.