IT 210 4-2 Case Study notes
An item recall When it comes to making financial decisions, systematic and unsystematic risks
are recognized to be unavoidable, thus one should be prepared to manage them if they do arise.
Systemic risk is described as a risk that has the ability to bring down a whole financial system,
including stock markets, which would have a terrible effect on the nation's entire financial
system. Systematic risks are defined as financial instability that can result in catastrophic
occurrences that disturb the market as a whole. According to Investopedia, systemic risk is the
risk that is present in every market or market sector as a whole. Systematic risk, commonly
referred to as "undiversifiable risk," "volatility," or "market risk," impacts the whole market
rather than simply one specific stock.
Both unanticipated and hard to entirely prevent, this kind of danger. Diversification cannot
reduce it; the only options are hedging and utilizing the right asset allocation strategy. 2020
(Investopedia) Uncertainty that comes with investing in a business or sector is known as
systemic risk. A new rival entering the market with the potential to significantly reduce the
invested company's market share, a change in regulations (which might reduce sales), a change
in management, and/or other factors are examples of unsystematic risk, according to
Investopedia. 2020 (Investopedia)
Systematic risk and unsystematic risk are distinct in a few ways. Unsystematic risk is risk that is
known to be tied to a particular industry, market sector, or security, whereas systematic risk is the
possibility of a loss that is connected to an entire market or segment. Another distinction between
these two risks is that systemic risk cannot be controlled in nature due to its larger scale and
frequent involvement of several other elements. Unsystematic risk, on the other hand, may be
managed since it only affects a single department, and because it is typically internal, it is
simpler and takes less time to minimize. Due to their larger-scale effects, systematic risks are
known to affect many securities within a market, whereas unsystematic risks only affect the
stocks or securities of a particular company or industry. Moreover, systematic risks may often be
managed by strategies like asset allocation and hedging, whereas unsystematic risks can
eventually be managed through portfolio diversification. Finally, systemic risk is based on two
main categories, known as business risk and financial risk, whereas unsystematic risk is known
to be separated into three different groups, including interest rate risk, purchasing power risk, and
market risk. It goes without saying that there will be dangers associated with every investment
that is undertaken. While making any investment-related choice, systematic and unsystematic
risk must be considered.
The danger of investment losses brought on by a change in interest rates is known as interest rate
risk. So, the value of a bond or other fixed income investment will decrease as interest rates
increase. Holding bonds with varying terms can also help to lower the risk of interest, and
investors can minimize this risk by hedging their fixed-income assets using interest rate swaps,
options, or other interest rate derivatives. (2021; Investopedia) The likelihood that an investment
may be impacted by macroeconomic factors such governmental regulation, exchange rates, or
political stability, albeit the most typical is in a foreign nation, is referred to as economic risk on
the other hand. “ Economic risk is one of the factors that makes foreign investing riskier. Also
susceptible are investors who engage in the selling and acquisition of foreign government bonds.
(ReadyRatios,2021) Another risk is credit risk, which is the possibility of suffering a loss as a
consequence of a previous borrower failing to pay back a loan or keep their end of the bargain.
The lender eventually suffers from a disruption in cash flows and higher collection expenses as a
result of not receiving the owing principle or interest. There is a chance that the borrower won't
be able to return the debt when lenders give mortgages, credit cards, or other sorts of loans.
Similar to that, there is a chance that a consumer won't pay their invoices if a business extends
credit to them. Credit risk also refers to the possibility that a bond issuer won't make a payment.
Operational risk is the final type of financial risk. Operational risk "summarizes the uncertainties
and dangers a firm encounters when it tries to conduct its routine business operations in a certain
sector or industry. This sort of business risk, which is different from difficulties brought on by
external causes like political or economic events or issues intrinsic to the whole market or market
sector and is known as systematic risk, can be caused by malfunctions in internal procedures,
people, and systems. (2021; Investopedia) Because it reflects human-made procedures and
thought processes, operational risk can be summed up as a human risk; it is the risk of business
operations failing. Operational risk concentrates on the accomplishments that are within an
organization rather than exactly what is produced within the industry. It varies from sector to
industry and should be taken into account when considering prospective investment choices.
Operations risk is probably lower in sectors where there is less involvement with people. (2021;
Investopedia) In contrast to times when sales are better, reduced sales growth would result in the
corporation decreasing its dividend yield payment policy and the quantity of retained earnings it
has. A higher dividend yield distribution strategy and greater quantity of retained earnings would
correspond to faster sales growth. According to the case study, the firm wouldn't require any
further external financing if its sales dropped by 5%, which would lower its demand for money
from $126 million to $0.00. Although higher Growth in sales does not usually indicate a need for
assistance from outside financial services.
