In this video, I will discuss investment risks such as systemic and unsystemic risk as covered o the CPA exam tax compliance and planning section.
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In investment, risk refers to the potential of losing some or all of the original investment. The level of risk in an investment often correlates with the expected return: higher risk might lead to higher returns, while lower risk usually aligns with lower returns. Understanding and quantifying this risk is a key part of investment planning.

There are two main types of investment risk: nonsystematic and systematic.

Nonsystematic Risk: This is the risk specific to an individual company or industry. It's also known as business risk and doesn't affect the entire market or economy. By diversifying investments – spreading them across different industries or asset types – investors can reduce nonsystematic risk. Examples include:

Default Risk: If you buy a company's bond, there's a risk the company might be unable to make interest payments or return the principal at maturity.
Management Risk: This relates to potential issues in a company's operations, such as losing a key executive or discontinuing a major product line.
Systematic Risk: This type involves risks that affect the entire market or economy and cannot be mitigated through diversification. Examples are:

Currency Risk: If you're investing in a company with significant foreign sales, fluctuations in exchange rates can affect your returns.
Inflation Risk: Also known as purchasing power risk, this is the danger that inflation will erode the real value of your returns.
Sociopolitical Risk: Events like political upheaval or social unrest can impact financial markets and investor attitudes, influencing the entire stock market.
While diversification can't shield you from systematic risk, other strategies like investing in derivatives or short selling can help manage this type of risk. For instance, if the market is declining, derivatives might provide gains, and short selling – selling an investment with the aim of buying it back at a lower price – could yield returns under these conditions.

In essence, understanding these risks helps investors make informed decisions that align with their risk tolerance and investment goals.








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