FIN 300 Lecture Notes - Lecture 12: S&P 500 Index, Risk Premium, Systematic Risk
10 Dec 2016
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Message 1: some risks look big and dangerous but are really diversifiable. If a risk is a unique risk, reflecting perils specific to a particular company, investors can avoid that risk by combining it in a diversified portfolio with many other assets or securities. From a investor"s perspective, unique risk need not be a concern. We use unique risk, unsystematic risk and asset-specific risk (idiosyncratic risk) interchangeably. Diversified portfolios are not exposed to the unique risks of individual holdings. However, they are exposed to uncertain events which affect the entire securities market or the entire economy. These systematic factors include changes in interest rates, industrial production, inflation, exchange rates and energy cost. When these systematic factors are favorable, investors do well and vice versa when they go the other way. We can measure how risky a stock is by comparing its price fluctuations to those of the market as a whole. Standard deviation or variance measures total risk.
