4-2 Case Study Assessing a Company\'s Future Financial Health PDF

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Systematic and Unsystematic are risks that are known to be inevitable when it comes to making financial decisions and a person should be ready to handle these risks if they occur. Systematic risk can be defined as a risk that can potentially collapse an entire financial system or even stock markets, which could cause a horrific impact on the entire financial system within the country. Systematic risks refer to financial instability that can cause devastating events that cause disruption in the overall market. In simpler terms and stated by Investopedia, “Systematic risk refers to the risk inherent to the entire market or market segment. Systematic risk, also known as “undiversifiable risk,” “volatility” or “market risk,” affects the overall market, not just a particular stock or industry. This type of risk is both unpredictable and impossible to completely avoid. It cannot be mitigated through diversification, only through hedging or by using the correct asset allocation strategy.” (Investopedia, 2020) Unsystematic risk is the uncertainty inherent in a company or industry investment. According to Investopedia, “ Types of unsystematic risk include a new competitor in the marketplace with the potential to take significant market share from the company invested in, a regulatory change (which could drive down company sales), a shift in management, and/or a product recall.”(Investopedia, 2020) There are a handful of differences between systematic risk and unsystematic risk. Systematic risk is the likelihood of a loss that is connected to an entire market or segment, whereas unsystematic risk is known to be connected to a specific industry, segment, or security. Another difference between these two risks is that Systematic risk can not be controlled in nature since it’s on a bigger scale and usually there are many other factors involved. Unsystematic risk on the other hand is able to be controlled because it’s only associated with one particular section, since these types of risks are normally internal it makes it easier and can be reduced in shorter time. Systematic risks are known to affect numerous securities within a market due to the larger

scale impact that is has, and unsystematic risk will only affect stock/securities of a certain firm or sector. The other differences between these two risks are that systematic risks can usually be controlled through practices like hedging and asset allocation and unsystematic risk can ultimately be taken care of through diversification of a portfolio. Lastly, Systematic risk is known to be divided into three different categories which include Interest rate Risk, Purchasing Power Risk, and Market Risk, whereas Unsystematic risk is based on two broad categories that are known as Business Risk and Financial Risk. It is obvious that with any investment that is going to be made it will always have risks that come along with it. Systematic and Unsystematic risk have to be accepted as factors when making any decision that involves investing. Interest rate risk is the possibility of investment losses that can result from a change in interest rates. So, if the interest rate rises, then a value of a bond or other fixed income investments will decline. The risk of interest can also be reduced by holding bonds of different durations, and “investors may also allay interest rate risk by hedging fixed-income investments with interest rate swaps, options, or other interest rate derivatives.” (Investopedia, 2021) Economic risk on the other hand refers to the possibility of an investment that will be affected by macroeconomic conditions like government regulation, exchange rates, or political stability, though the most common is in a foreign country. “Economic risk is one of the reasons for international investing carrying higher risk as compared to domestic investing. Bondholders and shareholders generally put up with the risk undertaken by international companies. Investors dealing in sale and purchase foreign government bonds are also exposed.” (ReadyRatios,2021) Another risk would be credit risk which is the potential of a loss resulting from a past borrower neglecting to repay back a loan or meet agreeing obligations. This ultimately effects the lender having a disruption of cash flows and increased costs of collections because the lender didn’t get

the owed principal or interest. “When lenders offer mortgages, credit cards, or other types of loans, there is a risk that the borrower may not repay the loan. Similarly, if a company offers credit to a customer, there is a risk that the customer may not pay their invoices. Credit risk also describes the risk that a bond issuer may fail to make payment when requested or that an insurance company will be unable to pay a claim.” (Investopedia, 2021) The last financial risk is known as operational risk. Operational risk “summarizes the uncertainties and hazards a company faces when it attempts to do its day-to-day business activities within a given field or industry. A type of business risk, it can result from breakdowns in internal procedures, people and systems—as opposed to problems incurred from external forces, such as political or economic events, or inherent to the entire market or market segment, known as systematic risk.” (Investopedia, 2021) Operational Risk focuses on the accomplishments that are within an organization and not exactly what is generated within the industry and therefore, “Because it reflects man-made procedures and thinking processes, operational risk can be summarized as a human risk; it is the risk of business operations failing due to human error. It changes from industry to industry and is an important consideration to make when looking at potential investment decisions. Industries with lower human interaction are likely to have lower operational risk.” (Investopedia, 2021) Lower sales growth would directly translate to the company lowering their dividend yield payout policy as well as lowering the amount of retained earnings they have compared to when sales are stronger. Higher growth in sales would be a higher dividend yield payout policy as well as a higher amount of retained earnings. After looking at the Case study if the company was to reduce their sales by 5% they wouldn’t have a need for additional external finance which would

drop their need for money from $126 million to $0.00. However, higher growth in sales doesn’t always mean that they need help from external financial services either.

References Chen, J. (2020, December 24). Unsystematic risk. Retrieved March 29, 2021, from https://www.investopedia.com/terms/u/unsystematicrisk.asp Chen, J. (2021, January 09). Interest rate risk definition. Retrieved March 29, 2021, from https://www.investopedia.com/terms/i/interestraterisk.asp Economic risk. (n.d.). Retrieved March 29, 2021, from https://www.readyratios.com/reference/analysis/economic_risk.html Fontinelle, A. (2020, December 14). Systematic risk. Retrieved March 29, 2021, from https://www.investopedia.com/terms/s/systematicrisk.asp LaBarre, O. (2021, March 24). What is credit risk? Retrieved March 29, 2021, from https://www.investopedia.com/terms/c/creditrisk.asp#:~:text=Credit%20risk%20is %20the%20possibility,and%20increased%20costs%20for%20collection. Segal, T. (2020, September 22). Reading into operational risk. Retrieved March 29, 2021, from https://www.investopedia.com/terms/o/operational_risk.asp Systematic risk vs unsystematic risk: Top 7 differences. (2021, February 23). Retrieved March 29, 2021, from https://www.wallstreetmojo.com/systematic-risk-vs-unsystematic-risk/ What is economic risk? Definition and example. (2020, November 26). Retrieved March 29, 2021, from https://marketbusinessnews.com/financial-glossary/economic-risk/...