non-systematic risk
(noun)
Risk that is unique to a specific company; can be reduced through diversification.
Examples of non-systematic risk in the following topics:
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The Relationship Between Risk and Return and the Security Market Line
- Investment assets are typically characterized as having two performance risks: systematic (or market risk) and non-systematic risk.
- Systematic risk arises from market structure or dynamics, which produce shocks or uncertainty faced by all agents in the market.
- Non-systematic risk is unique to a specific company and can be reduced through diversification.
- In finance, the capital asset pricing model (CAPM) is used to determine the required rate of return of an asset, taking into account an asset's sensitivity to non-diversifiable or systematic risk.
- For individual securities, the security market line (SML) and its relation to expected return and systematic risk (beta) depicts an individual security in relation to their security risk class .
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The Value of Diversification
- The risks that are inherent to a specific investment can be compensated for by a market-assessed risk premium, whereby market participants adjust the price of an asset, impacting its overall return, based on the risk characteristics of the asset.
- It's important to note that diversification does not remove all of the risk from the portfolio.
- Diversification can reduce the risk of any single asset, but there will still be systematic risk (or undiversifiable risk).
- Systematic risk arises from market structure or dynamics which produce shocks or uncertainty faced by all agents in the market.
- Systematic risk will affect the portfolio, regardless of how diversified it is.
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Government Failure
- Government failure, also known as non-market failure, is the public sector version of market failure .
- A government failure is not the failure of the government to enact a solution to a failure, but rather it is a systematic problem that prevents an efficient government solution to the problem.
- Regulatory arbitrage occurs when a regulated institution takes advantage of the difference between its real risk and the regulatory position.
- Regulatory risk is a risk faced by private sector firms when there is a chance that regulatory changes will negatively affect their business.
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Determinants of investment
- Firms can buy non-residential capital (buildings, equipment, etc. ) while individual consumers can buy residential capital (houses).
- Non-residential fixed investment: The amount purchased per unit time of goods which are not consumed, but are used for future production (capital).
- An example of non-residential fixed investment is investment in human capital, which includes additional schooling or training.
- Because all investments come with a certain amount of risk, the interest rate represents an opportunity cost.
- The level of risk can be seen to a certain extent when analyzing the income and interest rates, which allows the risks to be managed.
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Behavioral Economics: Irrational Actions
- Behavioral finance: the intent is to explain why market participants make systematic errors.
- Market inefficiencies: include the study non-rational decision making and incorrect pricing.
- The evaluation stage evaluated risky alternatives through the study of dependence, loss aversion, non-linear probability weighting, and sensitivity to gains and losses.
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Cost-Benefit Analysis
- Cost-benefit analysis, which is also sometimes called benefit-cost analysis, is a systematic process for calculating the benefits and costs of a project to society as a whole.
- The positive and negative effects captured by cost-benefit analysis may include effects on consumers, effects on non-consumers, externality effects, or other social benefits or costs.
- It is much more difficult to capture non-financial welfare impacts.
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Defining Capital
- In economics, capital references non-financial assets used in the production of goods and services.
- In economics, capital (also referred to as capital goods, real capital, or capital assets) references non-financial assets used in the production of goods and services.
- The value of financial capital is based on the market perception of expected revenues and risk.
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The Tragedy of the Commons
- Common goods are goods that are rivalrous and non-excludable.
- Fish populations are at risk of becoming fully extinct due to overfishing.
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The Special Case of Banking
- To protect the government from undue financial risk, regulators supervise banks and order corrective action if the banks are found to be taking undue risks.
- Prior to the Depression, many banks ran into trouble because they took excessive risks in the stock market or provided loans to industrial companies in which bank directors or officers had personal investments.
- By the 1980s, many depositors started seeking higher returns by putting their savings into money market funds and other non-bank assets.
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Economic Activities
- The process of creating new goods or processes is usually accompanied by risk.
- Innovation and risk are important elements of the entrepreneurial function.
- Individuals value security, aesthetics, creativity, leisure, a sense of belonging, and other non-market phenomena.
- The role of these things frequently arises in the allocation process because individuals may trade market goods for non-market values.