- This topic has 5 replies, 2 voices, and was last updated 4 years ago by
.
- Posts
Hi,
From my understanding, systematic risk cannot be diversified away even if an investor held a well diversified portfolio
My question is, can systematic risk be reduced?
For example, is covid 19 pandemic considered a systematic or unsystematic risk?
What if an investor had bought shares in ZOOM before this pandemic happened and their share prices increase significantly?
Systematic risk occurs in all businesses but the level is different in different types of business.
A company can only reduce it’s level of systematic risk by moving into other types of business that have less risk.
An investor can choose the level of systematic risk by choosing which shares to invest in (but the lower the systematic risk, the lower the return will be).
The pandemic would be regarded as being systematic risk, and although the stock markets as a whole have increased, the share price of Zoom has increased more. This would indicate a beta of more than 1.
Have you watched my free lectures on systematic and unsystematic risk?
Thanks
Yes, I have watched your lectures on CAPM
I don’t understand why the stock markets as a whole have increased during pandemic, I thought it should have decreased since most businesses are not doing well and thus the average of the share prices on stock exchange should be lower?
Then, the if the share prices are lower then the systematic risk should be higher, is it correct?
And if the share price of ZOOM has increased, then why would the beta is more than 1, shouldn’t it be less than 1 since it is less risky compared to the market as a whole?
I think I have must have understand something wrongly but I don’t know where did I go wrong. Can you explain?
Although stock markets overall dropped slightly at the start of the pandemic, overall they have increased (because of expectations of the future which is what determines share prices).
The risk of the market as a whole is determined by the extent to which the average market value of all shares fluctuates, and the average of the stock market does not stay static – it goes up and down. Some individual shares fluctuate more (and are therefore more risky than the market and have a beta of higher than 1) whereas others fluctuate less (and are therefore less risky than the market and have a beta of lower than 1).
Although the pandemic is really a rather poor example, because it is (hopefully) short-term, Zoom is a risky investment in that although at the moment the share price is rising more, this is likely to reverse as the world recovers and there is less need for the use of Zoom.
As such, CAPM would suggest that investors in Zoom will be requiring a higher return. I know this sounds the wrong way round because on its own a higher required return would mean a lower share price. However, remember that share prices depend on both the required rate of return and the expected future dividends. So although investors will be requiring a higher return because of the level of risk, they are currently expecting much higher dividends because the company is benefitting from the pandemic.The two together have resulted in the share price increasing, but as soon as the use of Zoom starts to fall as the pandemic ends, we would expect the share price to fall substantially.
- The topic ‘Systematic & Unsystematic risk’ is closed to new replies.