Week 2 Discussions (11-2-17) v2

Types of Risk – There are two types of risk. What are these two types of risk and should investors be concerned about them? By what methods are these risks measured by analysts?

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According to Mr. Damodaran, the two types of risk are (1) firm specific risk and (2) market risk.(1) Firm specific risk is, as the name suggests, risk specific to a single firm. Specific risk can also be described as diversifiable risk because it can be reduced significantly if not eliminated entirely by diversifying one’s portfolio. Varying investments, minimizes the risk impact made by any one investment since each investment will make up only a small portion of the overall portfolio. By diversifying, the risk of one individual investment within the portfolio can be absorbed by the positive performance of another individual investment. (Damodaran, 2012, chpt 4, pp 58-82).

It’s a balancing act between investments within the portfolio that can result in the reduction or elimination of this risk. Investors should be concerned with unsystematic risk because it is a manageable risk and a non-diversified portfolio is subject to dips in a firms stock without the benefit of other investments averaging out (balancing) the exposure. Investors and analysts can measure the temperament or volatility of a stock by first identifying its multiples and then comparing them to the industry or market. For instance, finding the price to book ratio is one way to measure price risk. The P/E ratio is also another way to measure price risk

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