Finance: Capital Asset Pricing Model and Systematic Risk Retrieved Essay

Submitted By sac525
Words: 722
Pages: 3

FINC605-1401B-01 John Stewart has recent joined ACG and needs help in preparing some educational material to help attract additional clients. As part of the current investment practices and theories, it is important to understand systematic and unsystematic risks. It is also important to understand the beta coefficient and how it ties into systematic and unsystematic risks. SYSTEMATIC RISKS A systematic risk is a risk that affects the overall market and not just a particular area of the stock (Investopedia, n.d.). This type of risk is also referred to as the market risk and can be volatile because it is not predictable. No one is immune to this risk and diversifying your portfolio does not protect you. The best way to protect your investments is by hedging or using the right asset collection strategy (Investopedia, n.d.) (Scottrade, 2014). There are many world events that can and have caused systematic risks. Events such as war, inflation, recessions, and interest rate changes affect the entire market and no one is exempt from their effects. A perfect example is the Great Recession that occurred in 2008. UNSYSTEMATIC RISKS Unsystematic risks are based on a person or companies performance when managing assets. Unsystematic risks tend to affect a very specific group of securities or an individual security. Very different from systematic risk is that it can be mitigated through diversification (Investopedia, n.d.). To combat unsystematic risks it is suggested to invest in multiple people or companies to diversify your portfolio (Scottrade, 2014). Therefore spreading the risk of the market and your portfolio will remain better protected. It is important to keep in mind that owning different stocks in different companies and other types of securities that investors will be less affected when there is a systematic impact (Investopedia, n.d.). Examples of unsystematic risks are when new competitors enter the market place, there are regulatory changes or even product recalls. One example that is recent was when the airlines employees were going on strike and the stock prices suffered because of this action. BETA COEFFICIENT To be able to determine how much of an effect the systematic risk has played on a particular security, portfolio or the like it can be done so with the utilization of the beta coefficient. The beta will measure how volatile the investment is compared to that of the rest of the market place (Investopedia, n.d.). A beta of greater than 1 means the investment has more systematic risk than the market. On the other hand if the beta is less than one it has less of a systematic risk, which in turn means that if the beta equals one then it is the same systematic risk as the rest of the market (Investopedia, n.d.). Beta is calculated using a regression analysis. It is not to say that a company with a beta greater than one is…