Introduction Any rational investor before investing his or her investible wealth in the stock, analyses the risk associated with the particular stock. The actual return he receives from a stock may vary from his expected return and the risk is expresses in variability of return. The downside risk may be caused by various factors, either common to all stocks or specific to a particular stock. Investor in general would like to analyse the risk factors and knowledge of the risks helps him to plan his portfolio in such a manner so as to minimise the risk.
Risk defined The dictionary meaning of risk is the possibility or loss or injury; the degree or probability of such loss. Risk consists of two components(I) Systematic risk(II) Unsystematic risk
Systematic risk: the systematic risk affects the entire market. Often we read in the newspaper that the stock market is in bear hug or in the bull grip. This indicates that the entire market is moving in a particular direction. The political changes, economic conditions, and sociological changes affect the security market. It can be of three types(I) Market risk(II) Interest rate risk(III) Purchasing power risk
Market risk: Market risk is that portion of total variability of return caused by the alternating forces of bull and bear markets. When the security index moves upward haltingly for a significant period of time it is known as bull market and the other situation is called bear market.
Interest rate risk: Interest rate risk is the variation in the single period rates of return caused by the fluctuations in the market interest rate. Most commonly interest rate risk affects the price of bonds, debentures and stocks. The fluctuations in the interest rates are caused by changes in the monetary policy and the changes that occur in the interest rates of treasury bills and govt. bonds.
Purchasing power risk: variations in return are caused also by the loss of purchasing power of currency. Inflation is the reason behind the loss of purchasing power. The level of inflation proceeds faster than the increase in the capital value. Purchasing power risk is probable loss in the purchasing power of returns to be received. The rise in price penalizes the returns to the investor, and every potential rise in price is a risk to the investor.
Inflation may be demand pull or cost push. Demand pull inflation: when prices go up because demand is more than the actual supply. Cost push: when company increases the prices so as to cover up the increasing cost.