Distinguish between systematic and unsystematic risk with suitable examples - (10 Marks)
Jasmeet Singh
(Audit Senior)
(911 Points)
Replied 07 March 2012
Systematic risks are unavoidable risks - these are constant across majority of technologies and applications. For example the probability of power outage is not dependant on the industry but is dependant on external factors. Systematic risks would remain, no matter what technology is used. Thus effort to seek technological solution to reduce systematic risks would essentially be unfruitful activity and needs to be avoided. Systematic risks can be reduced by designing management control process and does not involve technological solutions. For example, the solution to non availability of consumable is maintaining a high stock of the same. Thus a systematic risk can be mitigated not by technology but by management process. Hence one would not make any additional payment for technological solution to the problem. To put in other words there would not be any technology linked premium that one should pay trying to reduce the exposure to systematic risk
Jasmeet Singh
(Audit Senior)
(911 Points)
Replied 07 March 2012
Unsystematic risks are those which are peculiar to the specific applications or technology. One of the major characteristics of these risks would be that they can be generally mitigated by using an advanced technology or system. For example one can use a computer system with automatic mirroring to reduce the exposure to loss arising out of data loss in the event of failure of host computer. Thus by making additional investment one can mitigate these unsystematic risks. The management issue would be whether the additional payment to mitigate the risk is justifiable considering the possibility of loss that may or may not occur. The answer lies in identification of whether the overall risk exposure of the organisation is coming down because of the additional investment. It may be noted that every business has its inherent risk - the cost of running the business. In case of a technology driven business, the risks induced by technology failure is a part of the operating risk. The issue is how much of the risk is acceptable and what should be the price that one would pay to reduce a certain part of the risk. Cardinal to this issue is the ability to measure risk. Until the organisation has developed a process of risk and exposure measurement − it will be difficult to develop a model for risk management. Following this issue will be the risk appetite of the organisation − does it want to be risk aggressive or risk averter. The comparison will have to be made within the framework of the industry for ensuring usage of a consistent and relevant yardstick. For example, the risk appetite of risk aggressive bank may be far lower than that of a risk averse foreign exchange dealer.
Anshul Jain
(Article)
(33 Points)
Replied 07 March 2012
Prayash Sundas
(article Assistant)
(27 Points)
Replied 07 March 2012
Systematic risk is due to risk factors that affect the entire market such as investment policy changes, foreign investment policy, change in taxation clauses, shift in socio-economic parameters, global security threats and measures etc.
Unsystematic risk is due to factors specific to an industry or a company like labor unions, product category, research and development, pricing, marketing strategy etc.
Systematic risk is beyond the control of investors and cannot be mitigated to a large extent. In contrast to this, the unsystematic risk can be mitigated through portfolio diversification. It is a risk that can be avoided and the market does not compensate for taking such risks.
However the systematic risks are unavoidable and the market does compensate for taking exposure to such risks.
This logic forms the base for the capital asset pricing model. The greater is the systematic risk, the greater is the return expected out of the asset. The relationship between the expected returns and systematic risk is what the CAPM (Capital Asset Pricing Model) explains.
MANI.
(practice)
(317 Points)
Replied 07 March 2012
Ningappa Chandrasekar
(Accounts Head)
(21 Points)
Replied 25 October 2012
Seeking Answer for the following :
Mr. Bean Iron Company is considering to install a machine which costRs.1,00,000 The machine has a life of 5 years, and has no salvage value. The company’s tax rate is 50 per cent, and no investment allowance is provided. The company uses straight line depreciation. The estimated cash flows before tax from the proposed investment
proposal is as follows.
Sl.No. Year Cash Flow Before Tax
1. 2006-07 20,000
2. 2007-08 22,000
3. 2008-09 28,000
4. 2009-10 30,000
5. 2010-11 50,000
Compute the following:
a) Pay back period
b) Average rate of return
c) Net-profit value at 10% discount
d) Profitability index
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