Risk-

The dictionary meaning of risk is the probability of loss or injury, the degree of
probability of such loss. In risk, the probable outcomes of all the possible events are
listed. Once the events are listed subjectively, the derived probabilities can be assigned to
the entire possible events. Often risk is inter changeably with uncertainty. In uncertainty,
the possible events and probabilities of their occurrence are not known.Hence; risk and
uncertainty are different from each other.
Risk is the probability that an investment’s actual return will be different than expected.
Risk is an uncertain outcome or chance of an adverse outcome.

There are two types of risk-

1. Systematic Risk-Three types

a) Market Risk
b) Interest rate risk
c) Purchasing power risk

2. Unsystematic risk-Two types

A. Business risk-Two types
I. Internal Risk
II. External risk
B.Financial risk

Systematic Risk-This risk affect the entire market. It is caused by factors external
to the particular company and uncontrollable to the company. These are economic
conditions, political situations and the sociological changes.

Market Risk-According to Jack Francis, market risk as that portion of total

variability of return caused by the alternating forces of bull and bear market. When
security index moves upward for a significant period of time, it is a bull market. Bear
market is just a reverse of bull market, the index declines haltingly from the peak to a
market low point called through a significant period of time.

Interest rate risk- It is the variation in the single period rates of return caused by
the fluctuations in the market interest rate. Most commonly interest rate risk affects the
price of bonds, debentures and stock. The fluctuations in the market interest rate are
caused by changes in the government monetary policy and changes that occur in the
interest rates of treasury bills and government bonds. The bonds issued by the
government and quasi-government are considered to be risk free.

Purchasing power risk-Variations in the returns are caused by the loss of

Purchasing power of currency.Inflation, is the reason behind the loss of purchasing power
Purchasing power risk is the probable loss in the Purchasing power of the returns to be
received. The rise in price penalizes the returns to the investor and every potential risk in
price is a risk to the investor.

Unsystematic Risk -This risk is unique and peculiar to a firm or an industry. It

stems from managerial inefficiency, technological change in the production process,
availability of raw material, changes in the consumer preference and labour problems.
The nature and magnitude of these factors differ from industry to industry and company
to company. They have to be analyzed separately for each industry and firm.

Business Risk-It is that portion of unsystematic risk caused by the operating

environment of the business. Business risk arises from the inability of a firm to maintain
its competitive edge and the growth or stability of the earnings. A variation that occurs in
the operating environment is reflected on the operating income and expected dividends.

Internal Business Risk –It is associated with the operational efficiency of the
firm the operational efficiency differs from company to company. The efficiency of the
operations is reflected on the company’s achievement of its pre- set goals and the
fulfillment of the promises to the investors. Examples are-
• Fluctuations in the sales
• Research and development
• Single product
• Personnel management
• Fixed cost

External risk –It is the result of the operating conditions imposes on the firm by
circumstances beyond its control. The external environment in which it operates exerts
some pressure on the firm. A government policy that favors a particular industry could
result in the rise in the stock price of the particular industry. For instance, the Indian
sugar and fertilizer industry depend much on external factors. Examples are-
• Social and Regulatory factors
• Political Risk
• Business cycle

Financial Risk-It refers to the variability of the income to the equity capital due to
debt capital. Financial risk in a company is associated with the capital structure of the
company. Capital structure of the company consists of equity funds and borrowed funds.
The presence of debt and preference capital results in a commitment of paying interest or
pre fixed rate of dividend. The residual income alone would be available to the equity
holders. The interest payment affects the payments that are due to the equity investors.
The use of debt with the owned funds to increase the return to the shareholders is called
financial leverage. Debt financing enables the corporate to have funds at a low cost and
financial leverage to the shareholders.