Systematic Risk Principle: Definition, Types & Examples

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  • 0:02 Definition of Systematic Risk
  • 1:41 Types of Systematic Risk
  • 3:38 Lesson Summary
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Lesson Transcript
Instructor: Mary Rose

Mary is a CPA with a Bachelors and Masters degree in Accounting

In this lesson, you will learn about the principle of systematic risk. We will define the principle and identify types of systematic risk, and show some some common examples.

Definition of Systematic Risk

Investing funds in stocks, bonds, and other marketplace securities is a very common method of putting your money to use - hopefully to bring increased returns. There is, however, no guarantee that the invested funds will remain the same or even increase; there will always be some kind of risk associated with your investment. Some of this risk can be reduced by diversifying your investments (like that old saying goes, don't put all your eggs in one basket), but some risk cannot be entirely eliminated no matter how diversified your investments are. The component of risk that cannot be eliminated is known as systematic risk, and represents the risk which cannot be forecasted, predicted or controlled.

A great example of a non-forecasted, unpredicted and uncontrolled event leading to systematic risk is a recession, which is a period of time of slowed down economic activity. The relatively recent economic woes of 2008 highlighted how investments and risk can be impacted at a macro level. Portfolio values plummeted during this recession - literally overnight - and there was little that the investor could do to escape the effects. It had a macro, or large-scale, impact, domestically and globally.

Wars and natural disasters are other examples of systematic risk. These are large scale events that impact all areas of the investment arena, cannot be controlled, and cannot necessarily be predicted with 100% accuracy. Thus, these macro level, or large scale, events lead to systematic risk for the investor.

Types of Systematic Risk

Systematic risks are macro level risks that are external to an organization or individual. They cannot be controlled by the individual or organizations themselves, and the event leading to the risk impacts a large portion of the market. In general, systematic risk can be separated into three distinct types, all of which impact the return an investor will see on their investment.

Interest rate risk: This risk is associated with increases and decreases in the interest rate. For example, if you purchased stock in a particular company at $50 per share and their price falls to $35 per share, the value of your investment has not only decreased, but the interest or dividend you are likely to earn has also likely decreased. Maybe the returns from the investment can no longer be reinvested at the same rate of return? The risk is that your return on investment will be reduced due to uncontrollable market conditions.

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