The term risk refers to derivation from an expected outcome. The risk in holding an investment is generally associated with the rate of return. There are two types’ risks those affect the rate of return of the securities.
Total Risk= Systematic risk + unsystematic risk.
Systematic risk is also called non-diversifiable or market risk. Systematic risk refers to the variability of return of portfolio associated with change occur in the economic, political and social system. These changes affect the entries market i.e. all companies and all securities in varying degrees. Systematic risk cannot be diversified or unavoidable. Systematic risk of securities measured by a statically measures called Beta. Systematic risk is divided into three parts such as – interest rate risk, market risk, and purchasing power risk.
Interest rate risk
Interest rate risk particular affects the value of debt securities like bond and debentures. The fixed coupon rate of interest pays on these securities. The change in the market rate of interest relative to coupon rate of a bond causes the change in its market. The variation in bond prices caused due to variations in interest rates is known as interest rate risk.
Market risk is a type of systematic risk that affects shares. Generally, the rise in the price of stock refers to bullish market and fall in the price of stocks refers to the bearish market. The stock market is seen to be volatile. The variations in returns caused by the volatility of the stock market are referred to as market risk.
Purchasing Power Risk
Purchasing power risk is a type of systematic risk. It refers to the variation in investors return caused by the inflation. The inflation results in lowering of purchasing power of people. If an investor takes the decision to purchase a security, he forgoes the opportunity cost to buy the goods and services.