The term risk refers to derivation from an expected outcome. The risk of holding an investment is generally associated with the rate of return. There are two types’ risks that affect the rate of return of the securities.
Total Risk= Systematic risk + unsystematic risk.
Systematic Risk (SR) 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. These risks cannot be diversified, in simple terms they are unavoidable. Systematic Risk of securities measured by statistical 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 bonds and debentures. The fixed coupon rate of interest pays on these securities. The change in the market rate of interest relative to the 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 the bullish market and the 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 inflation. 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.