Write a short note on Systematic risk and non-systematic risk.

Systematic Risk vs. Non-Systematic Risk

Systematic Risk:

1. Definition: Systematic risk, also known as market risk, is the risk inherent to the entire market or an entire market segment. It cannot be eliminated through diversification because it is caused by external and uncontrollable factors that affect the overall market.

2. Causes: Systematic risk arises from factors such as changes in interest rates, inflation, economic recessions, political instability, and natural disasters, which affect all investments in the market.

3. Impact: Systematic risk affects the entire market and all investments within it. It cannot be diversified away and is a key consideration for investors when assessing their overall risk exposure.

4. Examples: Examples of systematic risk include a global economic downturn, a sudden spike in inflation, or a major geopolitical event that impacts financial markets worldwide.

5. Measurement: Systematic risk is typically measured using beta, which indicates how sensitive an investment is to movements in the overall market.

Non-Systematic Risk:

1. Definition: Non-systematic risk, also known as idiosyncratic risk or specific risk, is the risk that is unique to a particular company or industry. It can be reduced through diversification because it is specific to individual investments and can be offset by other investments in a portfolio.

2. Causes: Non-systematic risk arises from factors such as company management, competitive pressures, regulatory changes, and other company-specific events.

3. Impact: Non-systematic risk affects only a specific company or industry and can be mitigated by holding a diversified portfolio of investments. By spreading investments across different assets, investors can reduce the impact of non-systematic risk on their overall portfolio.

4. Examples: Examples of non-systematic risk include a company's poor financial performance, a product recall, or a lawsuit against a specific company.

5. Measurement: Non-systematic risk is measured using metrics such as standard deviation, which indicates the volatility of an individual stock or asset relative to its historical returns.

Key Differences:

1. Scope: Systematic risk affects the entire market or market segment, while non-systematic risk is specific to individual companies or industries.

2. Diversification: Systematic risk cannot be eliminated through diversification, while non-systematic risk can be reduced by holding a diversified portfolio.

3. Causes: Systematic risk is caused by external and uncontrollable factors, while non-systematic risk is caused by company-specific factors.

4. Impact: Systematic risk affects all investments in the market, while non-systematic risk affects only specific investments.

In summary, while both systematic and non-systematic risks are important considerations for investors, they differ in their scope, causes, and impact, highlighting the need for a diversified investment strategy to manage both types of risks effectively.