What is Unsystematic Risk?
Unsystematic risk can be termed as the risks generated in a particular company or industry and may not be applicable to other industries or economies as a whole. For example, the telecommunication sector in India is going through disruption; most of the large players are providing low-cost services, which are impacting the profitability of small players with small market share. As telecommunication is a capital-intensive sector, it requires enormous funding. Small players with low profitability and high debt are exiting the business.
Types of Unsystematic Risk
It is classified into two categories, namely:
- Business Risk – Business RiskBusiness RiskBusiness risk is associated with running a business. The risk can be higher or lower from time to time. But it will be there as long as you run a business or want to operate and expand. is related to the internal and external of a particular company.
- Financial Risk – Financial RiskFinancial RiskFinancial risk refers to the risk of losing funds and assets with the possibility of not being able to pay off the debt taken from creditors, banks and financial institutions. A firm may face this due to incompetent business decisions and practices, eventually leading to bankruptcy. is related to currency fluctuations, credit and liquidity riskLiquidity RiskLiquidity risk refers to 'Cash Crunch' for a temporary or short-term period and such situations are generally detrimental to any business or profit-making organization. Consequently, the business house ends up with negative working capital in most of the cases., political and demographic risk, etc.
Examples of Unsystematic Risk
ABC Limited is an automobile manufacturing company based in Europe. Due to a recent strike by the workers of the particular region, the manufacturing plant is closed, and the production activities are stopped for a while. But the demand of automobiles is the same, and the overall economic growth is intact. Thus, the above crisis can be sorted by means of conversation with the workers.
Unsystematic risks occur in case of large portfolios or funds under management. Suppose fund X has 15% exposure in the agriculture industry in Europe. Due to low harvesting in conditions across Europe, commodity prices have jumped up, followed by a slump in demand and reducing yields to the farmers. It is a pure case of unsystematic risk, and the matter is related to the agricultural segment in Europe only. So, the portfolio manager can divert the funds which are exposed to the agricultural industry. The funds can be diverted to US consumption, as the sector is going very strong in the recent past.
- It is strictly related to the particular business or the industry and does not impact the economy as a whole. As the nature of risk is business-oriented, the hazards can be controlled by taking several measures, unlike systematic risks.
- By diverting the portfolio or the business, one can avoid the risk and does not have the bad effect of the entire economy in systematic risks.
- Unlike systematic risks, the factors are majorly internal and can be removed by taking internal measures. While in case of deeper unsystematic risks, the problems can be long-lasting, and the remedies can be capital intensiveCapital IntensiveCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining..
- The impact is less severe than the systematic risk, and the scale of impact is relatively lower. While in some instances, the effect of the risk can be painful.
- In the case of systematic risk large number of people, capital is involved, while in unsystematic risk, the number of people and the amount of funds is less. It is related to a particular sector may not be repetitive; the evolution of new unsystematic risks are more than systematic risks.
- While even if the entire economy is going fine, a series of unsystematic risk can act as a hazard to the particular industry or the business. The profitability may be impacted due to the series of disruption to the business.
- Sometimes due to geopolitical crises, the risks cannot be avoided, and it takes a long time to settle. While due to lower productivity, investors and businessman feels the pinch as the demand for the product diminishes due to long unavailability of the product.
- Change of demand, change in preference of consumer taste may happen when the product is not available to the consumer. For example, lower availability of tea and tea-based products, the consumers might change the preference to coffee and coffee-based products. Thus, the above unsystematic risk can change the preference of the customers, leaving a permanent impact on the sector.
- The nature of risk in cases of unsystematic is not repetitive, and most of the time, there is an evolution of new hazards. The policymakers face challenges in resolving the risks as they have to deal with the utmost attention because of its nature.
- The critical situation may hinder the sentiment of the business. Many workers, employers may be badly affected due to the hazards. While in the case of systematic risks, the situations can be handled because of the known challenges associated with it.
- Policymakers have to implement a large pool of resources to resolve the situation. Sometimes the cost of measures becomes very expensive compared to the matter itself.
- Any kind of risk is unacceptable to the economy, be it systematic or unsystematic. The overall impact of the situation becomes negative to the common masses.
- The scale of operation is lower compared to the systematic risk; thus, the involvement of the government is also less. Most of the time, the private enterprise has to resolve the matter as it does not impact on the larger section of the economy.
- Because of its nature, the policymakers neglect the situations and does not comes under the limelight as in case of systematic risksSystematic RisksSystematic Risk is defined as the risk that is inherent to the entire market or the whole market segment as it affects the economy as a whole and cannot be diversified away and thus is also known as an “undiversifiable risk” or “market risk” or even “volatility risk”..
- The persons involved with the hazards are less in number compare to the systematic risks, and thus monetary compensation is also less or nil in case of unsystematic risks. There is a lack of government intervention in this type of risk.
The unsystematic risk is very much dynamic; the nature of problems is varied from each other. The enterprise which faces these problems experiences growth in profitability while the whole economy is going fine. There is no correlation with the broader economy, and the policymaker does not pay attention to the situation as the nature of the risks are focused to the specific industry or sectors, which could be eliminated by means of private participation only.
This article has been a guide to what is an unsystematic risk and its definition. Here we discuss types and examples of unsystematic risk along with limitations, advantages, and disadvantages. You can learn more about accounting from the following articles –