Topic 30

Systematic Risk

Topic 30 explores the factors giving rise to systematic risk. Systematic risk is captured in the beta of a security, which measures the volatility of a security arising from systematic risk to the market as a whole.

SYSTEMATIC RISK DEFINED

  • Systematic risk, as measured by beta, is a composite measurement of the volatility of a securities return associated with the sensitivity of the security with significant factors that affect the return on all securities.1 Such risk factors cause return variation throughout the financial markets and result from broad economic, political, or social change.2 Such factors may include:
    • Relative political stability
    • International events and perceived instability
    • Government tax policy effects
    • Inflation
    • Government monetary policy and actions
    • Interest rates
    • Economic health domestically and internationally
    • Investor confidence
  • The stock market will move up and down over time as these drivers exert their impact on all companies, their markets, and buyers and sellers in the market.
  • A security will systematically resonate with the market's response to these conditions either more or less than the market as a whole as measured by the beta of the security.
  • In determining the appropriate discount rate for valuing a target, buyers must consider the appropriate beta in the capital asset pricing model (CAPM) to determine an appropriate cost of equity capital to compensate for the level of systematic risk (an opportunity cost element) ...

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