SOURCES OF INVESTMENT RISK:
The fluctuation in an investment’s return attributable to changes in broad economic social or political factors which influence the return on investment is a systematic risk. It is that portion of total risk of a security which is caused by the influence of certain economic-wide factor like money supply, inflation, level of government spending and monsoon which have a bearing on fortune of every company. Systematic risk is undiversifiable risk and investors cannot avoid the risk from the above factors.
Unsystematic risk is the variation in returns due to factors related to the individual firm or security. It is that portion of total risk which arises from factors specific to a particular firm such as plant breakdown, labour strikes, sources of materials etc. it is possible to reduce unsystematic risk by adding more securities to the investor’s portfolio. All risky securities have some degree of unsystematic risk but combining securities into diversified portfolios reduces unsystematic risk from the portfolio. Therefore unsystematic risk is often referred to as diversified risk. The sum of systematic and unsystematic risks is equal to the risk of a security.