TYPES OF RISK Unfortunately, the concept of risk is not a simple concept in finance.

There are many different types of risk identified and some types are relatively more or relatively less important in different situations and applications. In some theoretical models of economic or financial processes, for example, some types of risks or even all risk may be entirely eliminated. It is ever-present and must be identified and deal with. In the study of finance, there are a number of different types of risk has been identified. It is important to remember, however, that all types of risks exhibit the same positive risk-return relationship. Risk can be classified into two types of risks which are as follows:

TYPES OF RISK

UNSYSTEMATIC RISK RRISK Controllable by an organisation Micro in nature

SYSTEMATIC RISK RRISK - Uncontrollable by an organisation - Macro in nature

Business Risk Liquidity Risk

Financial Risk

Operational Risk Liquidity Risk

Interest Rate Risk

Market Risk

Purchasing Power Risk

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1. UNSYSTEMATIC RISK It is a part of total risk which is unique to the firm or industry due to factors such as strikes, lack-out, consumer preferences and management policies. It is caused by the factors that are independent of the price mechanism operating in the security market. It is eliminated or minimized which is called unsystematic or unique risk. The unsystematic risk is also further classified into the followings. i) Business risk

The possibility that a company will have lower than anticipated profits, or that it will experience a loss rather than a profit. Business risk is influenced by numerous factors, including sales volume, per-unit price, input costs, competition, overall economic climate and government regulations. A company with a higher business risk should choose a capital structure that has a lower debt ratio to ensure that it can meet its financial obligations at all times. ii) Financial risk

The possibility that shareholders will lose money when they invest in a company that has debt, if the company's cash flow proves inadequate to meet its financial obligations. When a company uses debt financing, its creditors will be repaid before its shareholders if the company becomes insolvent. Financial risk also refers to the possibility of a corporation or government defaulting on its bonds, which would cause those bondholders to lose money. iii) Operational Risk

Operational risk can be summarized as human risk; it is the risk of business operations failing due to human error. Operational risk will change from industry to industry, and is an important consideration to make when looking at potential investment decisions. Industries with lower human interaction are likely to have lower operational risk.

2. SYSTEMATIC RISK External factors that cannot be controlled causes risk which are known as systematic risks. Systematic risks are non-diversifiable and they arise out of the factors such as market, nature of industry, state of the economy. Systematic risks can be further classified into: i) Interest rate risk

The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship. Such changes usually affect securities inversely and can be reduced by diversifying (investing in fixed-income securities with different durations) or hedging (e.g. through an interest rate swap). ii) Market risk

The possibility for an investor to experience losses due to factors that affect the overall performance of the financial markets. Market risk, also called "systematic risk," cannot be eliminated through diversification, though it can be hedged against. The risk that a major natural disaster will cause a decline in the market as a whole is an example of market risk. Other sources of market risk include recessions, political turmoil, changes in interest rates and terrorist attacks. iii) Purchasing power risk

Purchasing power risk is the uncertainties of the purchasing power of amounts to be received. It refers to the impact of inflation or deflation on an investment. High inflation erodes the capital value of all investments. It is also known as inflation risk. Variations in the returns are caused by the loss of purchasing power of currency and inflation causes the loss of purchasing power. In a sense, investment is regarded as the postponement of consumption. The higher the inflation rate, the faster the money losses its value. iv) Management risk

The risks associated with ineffective, destructive or underperforming management, which hurts shareholders and the company or fund being managed. This term refers to the risk of the situation in which the company and shareholders would have been better off without the choices made by management.

TOTAL RISK While there are many different types of specific risk, we said earlier that in the most general sense, risk is the possibility of experiencing an outcome that is different from what is expected. If we focus on this definition of risk, we can define what is referred to as total risk. In financial terms, this total risk reflects the variability of returns from some type of financial investment.