It refers to that portion of total variability in return caused by factor affecting the prices of all securities. The sources of such a risk are economic, political and sociological changes. This results in prices of all common stocks to move together in the same manner.
Systematic Risk Includes
1. Market Risk: There are many causes, but is mainly due to a change in investors’ attitude toward equities in general, or toward certain types or groups of securities in particular.
2. Interest rate risk: refers to the uncertainty of future market values and of the size of future income, caused by fluctuations in the general level of interest rates.
3. Purchasing power risk: is the uncertainty of the purchasing power of the amounts to be received. In short, purchasing power refers to the impact of inflation or deflation of an investment.
Rising prices on goods and services are normally associated with what is referred to as inflation. Falling prices on goods and services are termed deflation.
Unsystematic or Diversifiable Risk
It is the portion of total risk that is unique to a firm or industry. Factors causing such risk are management capability, consumer preferences, and labour strikes. These factors affect one firm and they must be examined for each firm.
The uncertainty surrounding the ability of the issuer to make payments on securities has two sources (i) the operating environment of the business and (ii) the financing of the firm.
1. Business Risk : is a function of the operating conditions faced by a firm and the variability these conditions inject into operating income and expected dividends. The degree of variation from the expected trend would measure business risk.
2. Financial risk: is associated with the way a firm finances its activities. By engaging in debt financing, the firm changes the characteristics of the earnings stream available to the common stock holders, as interest on debt is paid before dividend payment.