Diversifiable risk refers to the portion of an assets risk attributable to firm-specific, random events (strikes, litigation, loss of key contracts, etc.) that can be eliminated by diversification. Nondiversifiable risk is attributable to market factors affecting all firms (war, inflation, political events, etc.).
Herein, what is Diversifiable risk and Nondiversifiable risk?
In this framework, the diversifiable risk is the risk that can be “washed out” by diversification and the nondiversifiable risk is the risk which cannot be diversified away. It appears to us that the decomposition of risk into its components is in some cases vague and in most cases imprecise.
Subsequently, question is, why is some risk Diversifiable and some risk non Diversifiable? Diversifiable risk is the risk of price change due to the unique features of the particular security and it is not dependent on the overall market conditions. Diversifiable risk can be eliminated by diversification in the portfolio. Non-diversifiable risk is the risk common to the entire class of assets or liabilities.
Similarly one may ask, what is Diversifiable risk?
Diversifiable risk is the possibility that there will be a change in the price of a security because of the specific characteristics of that security. Diversification of an investors portfolio can be used to offset and therefore eliminate this type of risk.
What do you mean by non Diversifiable risk?
non-diversifiable risk. Risk of an investment asset (bond, real estate, share/stock, etc.) that cannot be reduced or eliminated by adding that asset to a diversified investment portfolio. Market or systemic risks are non-diversifiable risks.
unsystematic risk. The risk that is specific to an industry or firm. Examples of unsystematic risk include losses caused by labor problems, nationalization of assets, or weather conditions. Also called diversifiable risk.
Types of unsystematic risk include a new competitor in the marketplace with the potential to take significant market share from the company invested in, a regulatory change (which could drive down company sales), a shift in management, and/or a product recall.
Definition of Unique Risk. Also called unsystematic risk or idiosyncratic risk. Specific company risk that can be eliminated through diversification. See: Diversifiable risk and unsystematic risk.
Total risk is an assessment that identifies all of the risk factors associated with pursuing a specific course of action. The goal of examining total risk is to make a decision that leads to the best possible outcome.
In finance, risk refers to the degree of uncertainty and/or potential financial loss inherent in an investment decision. In general, as investment risks rise, investors seek higher returns to compensate themselves for taking such risks.
verb (used with object), di·ver·si·fied, di·ver·si·fy·ing. to make diverse, as in form or character; give variety or diversity to; variegate. to invest in different types of (securities, industries, etc.).
Speculative risk is a category of risk that can be taken on voluntarily and will either result in a profit or loss. Almost all financial investment activities are examples of speculative risk, because such ventures ultimately result in an unknown amount of success or failure.
It defines risk as: (Exposure to) the possibility of loss, injury, or other adverse or unwelcome circumstance; a chance or situation involving such a possibility. Risk is an uncertain event or condition that, if it occurs, has an effect on at least one [project] objective.
Within these two types, there are certain specific types of risk, which every investor must know.
- Credit Risk (also known as Default Risk)
- Country Risk.
- Political Risk.
- Reinvestment Risk.
- Interest Rate Risk.
- Foreign Exchange Risk.
- Inflationary Risk.
- Market Risk.
-Beta measures non-diversifiable risk and standard deviation measures total risk. The average stock has a beta of 1.0. A beta higher than 1.0 is more risky than the market portfolio, while a beta less than 1.0 is less risky than the market portfolio.
Types of financial risk
Market risk (systematic. Systematic risk is caused by factors that are external to the organization. All investments or securities are subject to systematic risk and therefore, it is a non-diversifiable risk., affecting all firms in the market)
Pure risk, also called absolute risk, is a category of threat that is beyond human control and has only one possible outcome if it occurs: loss. Pure risk includes such incidents as natural disasters, fire or untimely death.
Unsystematic risk is measured through the mitigation of the systematic risk factor through diversification of your investment portfolio. The systematic risk of an investment is represented by the companys beta coefficient. Find the beta coefficient for your stock investment.
Unsystematic risk (also called diversifiable risk) is risk that is specific to a company. This type of risk could include dramatic events such as a strike, a natural disaster such as a fire, or something as simple as slumping sales. Two common sources of unsystematic risk are business risk and financial risk.
Non diversifiable risk is the fluctuation of returns caused by the macroeconomic factors such as war,inflation, business cycle etc that affect all risky assets. Diversifiable risk is the risk of something going wrong on the company or industry level such as mismanagement, labour strikes etc.
But if an investor owns a diversified portfolio of 20, 30, or 40 individual investments, the damage done to the portfolio is minimized. The important concept of unsystematic risk is that it is not correlated to market risk and can be nearly eliminated by diversification.
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