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Investigating Systematic And Idiosyncratic Risks In Money, Banking And Financial Markets

1219 words - 5 pages

Risks, the Effects and Affected
Rose Smith
Montclair State University
April 13, 2014
Author Note
This paper was prepared for Economics 301, Section 01, taught by Professor Ramjerdi

Risks, the Effects and Affected
At some point in our lives, we have all experience some form of risk either a systematic or idiosyncratic risks. According to authors, Stephen G. Cecchetti and Kermit L. Schoenholt’z book, Money, Banking, Financial Markets, “Risk is everywhere. It comes in many forms and from almost everywhere imaginable place. All risks can be classified into one of two groups: (1) those affecting a small number of people but no one else (unique or idiosyncratic risks) and (2) those affecting everyone (systematic or economy wide risks) (ch.5 p.110).” The main point of this paper is to investigate systematic and idiosyncratic risks, what causes each to occur and how they can be eliminated if possible.
What are Risks?
A systematic risk or economy wide risks is believe to be the worst of the types of risks because it cannot be avoided and it can also be very detrimental to governments, firms and households making it much harder to recover from the losses. There are also “macroeconomic factors, such as swings in consumer and business confidence brought on by global economics conditions or changes in the political climate. For History tells us that when oil prices rise, auto sales fall, and the automobile industry suffers (ch.5 p.111).” Another famous example of an economy wide risks is the Housing Bubble Crisis. In 2008, the economy experience a recession that left behind in its wake thousands of people having their homes foreclosed and homeless. Many people also lost their jobs and lifesavings due to businesses losing profits sending the unemployment rate to 10 percent. Some companies could not sustain the downturn of the economy like the Lehman Brothers. Forbes’s magazine author Steve Schaefer’s article, The Great Recession’s Biggest Bankruptcies: Where Are They Now? Offered some insight by describing the Lehman Brothers disaster as “the largest corporate bankruptcy in United States history, their valuable assets were sold off in a chapter 11 bankruptcy and the rotting carcass was left to be disposed of by a trustee.” Lehman Brothers had an overwhelming debt totaling $619 billion dollars. This systematic risk was unavoidable due to the subprime mortgage crisis as a result it had a domino effect which spread like wildfire to other financial institutions domestic and international like The Bank of New York Mellon and the Bank of Japan which had either lend money to or invested in Lehman Brothers. Companies saw their stocks declined rapidly because Lehman Brothers’ chapter 11 bankruptcy case.
Idiosyncratic risks are less extreme than systematic risks. “Idiosyncratic risks comes in two types. First, one set of firms is affected in one way and other firms in another way. An example would be a change in the price of oil (ch.5 p.111).” This...

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