The Sources of Risk - Business Finance - ثاني ثانوي

Link to digitat lesson 6.3 The Sources of Risk www.ten.edu.sa Diversifiable risk Uncertainties associated with Individual events that affect a particular asset: firm-specific uncertainty that is reduced by diversifying investment portfolios Vediversable visi Sym Uniceranties associated with fluctuations in securities prices and other non firm specific factors market uncertainty that is not reduced through the construction of diversified Key Terms Diversifiable risk (Unsystematic risk) Undiversifiable risk (Systematic risk) If there were certainty, there would be no risk. In the real world, there is uncertainty, which requires the financial manager or investor to analyze possible outcomes and assess the investment's risk. Of course, the realized outcome may be better than expected, but the emphasis in the analysis of risk is on the negative: the outcome will be worse than expected. Since financial decisions are made in the present but the results occur in the future, risk permeates all financial decision making. The future is not certain; it is only expected. However, sources of risk can be identified. These are frequently classified into "diversifiable" risk and "undiversifiable" risk or "unsystematic risk" and "systematic risk". (Both sets of terms are used to differentiate the sources of risk.) Diversifiable risk A diversifiable risk (or unsystematic risk) refers to the risk associated with the individual asset. Since the investor buys specific assets, such as the stock of or the bonds of a company, that individual must bear the risk associated with each specific investment. Sources of diversifiable risk: 1. Business risk: refers to the nature of the firm's operations. 2. Financial risk: refers to how the firm finances its assets. Undiversifiable risk Undiversifiable risk (or systematic risk, sometimes called non-diversifiable risk) refers to those sources that are not reduced by diversifying investment portfolios. 236Business Finance

Sources of undiversifiable risk: 1. Market risk: the risk associated with movements in securities prices. 2. Interest rate risk: the risk associated with fluctuations in interest rates. 3. Reinvestment rate risk: refers to the risk associated with reinvesting funds generated by an investment. 4. Purchasing power risk: is the risk associated with inflation. 5. Exchange rate risk: is the risk associated with fluctuations in the prices of foreign monies. 6. Sovereign risk: applies to investing in the debt obligations of a specific country and the possibility that the government will default. Why might diversification important for investan CONSTITUENT ASSETS MANY VARIETY DIVERSE PORTFOLIO CHANGE Geographical REDUCE RISK Company Assets CLASSES DIVERSIFICATION DIVERSE Investments STRATEGY REDUCE RIS Products 1-18 Diverse SERVICES Knowledge Technology

Business Finance Exercises Choose the correct answer. 1. A diversified portfolio: a. increases systematic risk. b. reduces systematic risk. c. increases unsystematic risk. d. reduces unsystematic risk... 2. Systematic risk is reduced through portfolio diversification. True/False