Financial Management: Evaluating Systematic and Unsystematic Risks in Investment

This document discusses the evaluation of systematic and unsystematic risks in investment in financial management. It explores the impact of external factors and firm-specific risks on securities trading. The document also provides strategies to mitigate risks and maximize profit.

Running Text: Financial Management
Financial Management

Financial Management
The Public Companies often invest their money in the securities of different companies. The
reason behind it is to make money out of the cash they have with themselves. These public
companies often carry out a proper evaluation in order to maximise the profit and minimise
the risk, before making investment in any of the securities.
If we talk about securities then risks are considered to be unavoidable as a result the return
earned on the securities are sometimes less than the expected return. There are certain
components of risk that contribute to the differences in the returns expected. However, if we
talk about the investments then broadly there are two types of risk involved which could be a
systematic risk and unsystematic risk.
Systematic risks refer to those risks which take place because of the external factors. These
factors can be the result of sociological, political as well as economic changes taking place in
the country. These risks are usually not under the control of management. Also, such risks
have their impact on multiple securities trading in the market.
Unsystematic risks are those risk which are under the control of management of the company.
These risks are firm specific risk and it usually affects a particular firm or industry. Example
of unsystematic risk could be related to the strikes by the factory labours, marketing of the
product, fire, downward trend shown by the sales etc. It can also be termed as ‘Diversifiable
risk’ or ‘Residual risk’ (Fadilah and Witiastuti, 2018).
Let us take an example where the Public Company has to invest in a consumer electronic
business. Before making the investment it will have to find the factors relating to systematic
and unsystematic risk present for the consumer electronic business. Here, the factors giving
rise to the systematic risk can include US China Trade war and the expected worldwide
global recession.
If we talk about the effect of US- China trade war on the stocks of consumer electronic
business then its effect could be large (The Sydney Morning Herald, 2018). For example, the
sale of iPhone, the most revenue fetching product of Apple, may go down as a result of trade
disturbance between the two countries that are US and China. As it was noticed, that the
company cut down the price of iPhone in China as a result of low sales in the country but still
the conditions did not improve a lot rather in the worst case further tariffs may hurt the sale of
iPhone in China. So, for a public company it is not advisable to put their money in the
consumer electronic businesses which are exposed to the risk relating to US-China trade war.
While considering the investment plan, we cannot ignore the effect of expected slowdown on
a worldwide level (The Sydney Morning Herald, 2019). As a result of economic slowdown,
the sales of the electronic items may go down. Even the company like Dell Technologies Inc.
had said that they can witness a drop in their sales growth. The corporate demand for the
hardware may go down because of the struggles to be faced by them relating to the economic
slowdown (Bloomberg, 2019). So, again the risk relating to the economic slowdown should
be considered by the public company before investing into any electronic company. Still, in
order to mitigate the above mentioned systematic risk, the investment can be made in
completely dissimilar markets and may even opt for making investment in different segment.
In case the companies are bullish on the stock of any company, then it may enter into futures
contract in the derivative market. Futures contract here refers to the agreement of buying or
selling an underlying asset, which could be currency, market index, stock index etc., at a
future point of time at a pre-set price (FXCM, N.D.). Here, the investors either carry out the
purchase of ‘right to buy’ or the ‘right to sell’ the underlying asset at a scheduled price. At
1

Financial Management
the time of purchasing the right to buy, the investor expects for the profit resulting from an
increase in underlying assets’ price. However, at the time of purchasing the right to sell, the
investor expects for the profit resulting from the fall in price of underlying assets.
There are even unsystematic risks relating to any electronic company which differs from
company to company. Say for example, the smart phones in the Australian market are on the
verge of saturation. However, the saturation is still not affecting the sale of phones on a large
scale and the reason could be introduction of unlimited 5G data pack (Deloitte, 2018). But if
we look on the other side, then this mobile market saturation could prove as a sign of danger
for the company and so for the investors in future. Hence, if a Public company is looking
forward to invest in the consumer electronic company then it should avoid opting for the
companies dealing in smart phones. Nevertheless, even unsystematic risk can be reduced with
the help of diversification. Diversification, in a layman terms, refers to the concept of not
putting all the eggs in a single bag. In the stock market it is always advisable to invest in the
stocks of different companies and some sometimes in completely different sectors. For
example, if an investor invest the whole amount in a company belonging from consumer
electronics sector and due to some labour strike the productivity of the company got
hampered resulting a fall in the company’s share in the stock market and a complete loss of
money invested. In such cases, the investor could have avoided the loss if he would have
made the investment in some different companies belonging from the different sectors,
segments, industries and could even had invested the amount in different asset class like
government bonds, fixed deposits, real estate, commodities etc. (QSuper, 2019).
So, if a public company is looking for making an investment in consumer electronics
company or any other specific companies belonging from different sectors, it should evaluate
both systematic and unsystematic risk properly. Then proper mitigating and diversification
strategies should be applied for avoiding and minimizing the effect of such risks in order to
earn the maximum profit from the invested amount.
2

Financial Management
References
Deloitte, (2018). Mobile Consumer Survey 2018 Behaviour Unlimited. [Online]. Available 23 April,
2019 https://www2.deloitte.com/au/mobile-consumer-survey
Fadilah, I., & Witiastuti, R.S. (2018). A clustering method for portfolio optimization.
Management Analysis Journal, [Online]. 7(4), p. 437-447. Available 23 April, 2019
https://journal.unnes.ac.id/sju/index.php/maj/article/view/23378/12674
FXCM, (N.D.). Introduction to futures trading. [Online]. Available 23 April, 2019
https://www.fxcm.com/au/insights/introduction-to-futures-trading/
The Sydney Morning Herald, (2018). Donald Trump’s Trade War will cost Australia’s
economy at least $36Billion. [Online]. Available 23 April, 2019
https://www.smh.com.au/politics/federal/donald-trump-s-trade-war-will-cost-australia-s-economy-
at-least-36-billion-20180907-p502dr.html
The Sydney Morning Herald, (2019). The Global Economic Slowdown is accelerating- and
Australia is vulnerable. [Online]. Available 23 April, 2019
https://www.smh.com.au/business/the-economy/the-global-economic-slowdown-is-accelerating-
and-australia-is-vulnerable-20190122-p50suq.html
QSuper, (2019). Asset Classes. [Online]. Available 23 April, 2019
https://qsuper.qld.gov.au/performance/investment-basics/asset-classes
3

Financial Management
4