It is common to divide all investment risks into systemic and non-systemic risks depending on the extent to which a wide range of stock market instruments are at risk of being affected on a case-by-case basis.
Non-systemic risks are risks that can only be exposed to individual securities or small groups of securities.
These risks are also referred to as "individual securities risk" or "unique risk," since such risks tend to be inherent in securities only to a particular bank or, moreover, only to specific financial instruments.
Consider some non-systemic risks:
- liquidity risk - demand for certain securities may change significantly, including for long periods of time;
- financial risk - the share price of a commercial bank may vary depending on its management 's financial policy.
- default risk - the issuer may, for various reasons (e.g. bankruptcy), be unable to meet its obligations to its holders on time or at all.
To minimize non-systemic risks, use a risk diversification approach that requires an investment portfolio.
By creating an investment portfolio, an investor makes up a set of several financial instruments issued by different issuers, and therefore exposed to different non-systemic risks.
Thus, the investor seeks to diversify investment risks, that is, to avoid simultaneously changing the yield of each instrument in the same direction.
At the same time, the fewer securities in the investment portfolio, the higher the level of risk.
The method of diversification with regard to minimizing non-systemic risks has proved to be very effective, provided that a sufficiently large investment portfolio is developed.
System risk refers to risks that are not inherent in dealing with individual securities, but with certain sets of securities, to a greater or lesser extent, for each of the securities in that set.
Systemic risks are also referred to as "investment portfolio risk" or "market risk."
The latter name was given to systemic risks because they are influenced by the whole market or a large part of it.
Accordingly, most attention to systemic risks should be paid to those investors who prefer to invest in individual instruments to form an investment portfolio.
Systemic risks are caused by possible uncertainties in the economic situation in the market as a whole, general trends in the market as a whole, and therefore affect the securities of almost all issuers operating in the market.
In the case of systemic risks, the diversification method is not in place, and it is extremely difficult to avoid the risk of loss in the course of investment.
Let 's look at some system risks:
- interest rate risk - caused by interest rate fluctuations. Especially relevant for debt holders such as bonds.
- exchange rate risk - the risk inherent in investments in securities of foreign issuers and directly related to exchange rate fluctuations.
- inflation risk - Unexpected inflation increases lead to forced changes in the activities of issuers and may significantly affect the share price.
- political risk - unexpected, especially dramatic, changes in the political situation inevitably affect the stock market, often very unfavorable.
To minimize non-systemic risks, the portfolio manager can apply a method such as portfolio diversification.
The main threat to the investment portfolio is systematic risks, as they are hardly managed by portfolio managers.