Meaning of Risk

An individual expects to get some return from his investment in the future. But, as future is subjected to change, so is the return. It is due to this return associated uncertainty from an investment that brings in risk into an investment.

In an investment, we can differentiate between the realized and expected  return. The expected return is the uncertain future that an investor expects to get from his investment. On the contrary, at the end of the holding period, the realized return is the specific return that an investor has actually received from his investment. 

Element of Risk 

The fluctuation in its returns is the essence of risk in an investment which is caused by a number of factors. These factors which raise fluctuation in the returns from an investment comprise the elements of risk.

The total fluctuation in returns of a security constitutes the total risk of that security. Systematic and unsystematic risk are the forms of total risk. Thus,

Systematic Risk 

As the society is dynamic, alters occur in the political, economic, and social systems constantly.  Thus, the performance of the companies and  their stock prices influenced by these changes ,but all companies and all securities were get impacted in varying degrees. For example, there is adverse impact of economic and political instability on all companies and industries. During recession, corporate profits shift downwards and stock prices of most companies decline. Thus, the impact of political,social and economic  changes is system-wide and that part of total fluctuation  in security returns caused by such system-wide factors is known as systematic risk. 

Interest Rate Risk 

Interest rate risk is a mode of systematic risk that in particular affects debt securities like debentures and bonds. A debenture or bond generally has a fixed coupon rate of interest. At this coupon rate, the issuing company pays interest to the bond holder. A bond is generally issued with a coupon rate which is equal to the rate of  interest  persisting in the market at the time of issue. Accompanying to the issue, the market interest rate may vary but the coupon rate remains constant till the instrument  maturity. The variation in the market interest rate relative to the coupon rate of a bond leads to the variation in its market price.

Market Risk 

Market risk is a sort of systematic risk that impacts shares. For a time frame, the prices of shares move up or down consistently. A general rise in share prices is known as bullish trend, whereas a fall in share prices is known as a bearish trend. In other words, the share market jumps between the bearish and bullish phase.

Unsystematic Risk

The returns from a security may sometimes alter due to certain factors influencing only the company issuing such security. For an example, labor strike,  raw material scarcity and management inefficiency. When ups and downs of returns occurs due to  such firm specific factors, it is referred as unsystematic risk.

The unsystematic also known as  unique risk influencing certain securities arises from two sources:
(a) The company's operating environment.
(b) The company's financial pattern.

These two types of unsystematic risk are known as business risk and financial risk respectively.  

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