What is systematic risk?

Question

BlackTom AI · Accepted Answer

The question asks: What is systematic risk?

Context note: The provided data shows the question, but the list of answer options is empty (answer_options: []). There is, however, a single answer given in the answer field: "It cannot be eliminated through diversification."

Since there are no alternative options to compare, I will focus on explaining the concept of systematic risk and why the stated option is correct in general terms, along with what would make other possible options incorrect if they existed.

Understanding systematic risk: Systematic risk, also known as market risk or non-diversifiable risk, refers to the portion of an asset's risk that arises from overall market or economy-wide factors. These include interest rate changes, inflation, recessions, geopolitical events, and broad financial crises. Because these factors affect nearly all securities, diversification across different assets cannot eliminate this risk.

Why the given option is correct: The statement "It cannot be eliminated through diversification" accurately captures the essence of systematic risk. Even a well-diversified portfolio will still experience fluctuations due to broad market movements. Diversification can reduce unsystematic (idiosyncratic) risk—risk specific to a single asset or company—but it does not remove systematic risk.

Potential reasoning about what other options might claim (and why they would be wrong): If an option suggested that systematic risk can be eliminated by diversification, that would be incorrect, because the core driver is market-wide factors that affect a wide array of investments simultaneously. If an option claimed systematic risk is only about negative returns or only affects stock markets (and not bonds, etc.), that would be misleading because systematic risk encompasses movements that impact many asset classes, not just equities. If an option claimed systematic risk is entirely avoidable through hedging alone, it would be misleading as well; hedging can mitigate some exposure but cannot eliminate the inherent market-wide variance entirely.

In summary, the presented statement aligns with the standard definition of systematic risk: it is non-diversifiable and stems from broad market factors rather than company-specific factors. If additional options were available, they should be evaluated against this fundamental idea to determine their correctness.

COMM_V 298 201-207 2024W2 Class 14: CAPM Practice Quiz

What is systematic risk?

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Systematic risk...

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