Thursday, 22 January 2009

Partitioning Risk

Partitioning Risk


Risk has many subsets.


Total risk is all-inclusive and refers to the overall variability of the returns of a financial asset.


The two components of total risk are
· Un-diversifiable risk (also called systematic risk or market risk) and
· diversifiable risk (also called unsystematic risk).


Undiversifiable risk is that which must be borne by virtue of being in the market. This risk arises from systematic factors that affect all securities. We quantify systematic risk by beta.

Subsets of Risks:

Business risk
Financial risk
Purchasing power risk
Interest rate risk
Foreign exchange risk
Political risk
Social risk

Risk and the Income Statement
Sales: Foreign exchange risk, Social risk, Business risk
Tax: Political risk
Dividends: Political risk
Contribution to Retained Earnings: Financial risk

Risk and the Balance Sheet
Total Assets
Financial assets: Interest rate risk, default risk, systematic and unsystematic risk, foreign exchange risk.
Real assets: Foreign exchange risk

Total Liabilities and Net Worth
Liabilities: Interest rate risk, foreign exchange risk
Net worth: Purchasing power risk

No comments: