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Types of Risk
Risk Premium
Equity risk premium refers to the excess return that investing in the stock market provides over a risk-free rate. This excess return compensates investors for taking on the relatively higher risk of equity investing. The size of the premium varies depending on the level of risk in a particular portfolio and also changes over time as market risk fluctuates.
Systematic and Unsystematic Risk
Systematic Risk
Systematic Risk does not have a specific definition but is an inherent risk existing in the stock market. These risks are applicable to all sectors and affect the entire stock market at the same time. If there is an announcement or event which impacts the entire stock market, a consistent reaction will flow in which is a systematic risk. Systematic risk is often referred to as "market risk", and the symbol is used when measuring it.
For Example:
If Government Bonds is offering a yield of 5% in comparison to the stock market which offers a minimum return of 10%. Suddenly, the government announces an additional tax burden of 1% on stock market transactions, this will be a systematic risk impacting all the stocks and may make the Government bonds more attractive.
Unsystematic Risk
Unsystematic Risk is an industry or firm-specific threat in each kind of investment. It is also known as "Asset-specific Risk" or "Diversifiable risk" or "Idiosyncratic risk". These are risks which are existing but are unplanned and can occur at any point in causing widespread disruption.
For Example:
If the staff of the airline industry goes on an indefinite strike, then this will cause risk to the shares of the airline industry and a fall in the prices of the stock impacting this industry.
Total Risk = Unsystematic Risk + Systematic Risk
