Which type of risk cannot be diversified away?

Which type of risk cannot be diversified away?

• A. Unsystematic risk.
• B. Firm-specific risk.
• C. Systematic risk affects the entire market and cannot be eliminated by diversification.
• D. Operational risk within a company.

Answer: (C)

Systematic risk is the part of risk that comes from overall market factors that affect virtually all assets, such as changes in interest rates, inflation, recessions, or major geopolitical events. Because these forces move the entire market, simply holding a broader or more diverse set of securities cannot eliminate them. Even a well‑diversified portfolio will still be influenced by market-wide movements, so this risk remains as the non-diversifiable portion of return variability. The amount of risk tied to market movements is often described with beta, reflecting how a security or portfolio tends to move with the market; diversification can reduce idiosyncratic, or firm‑specific, risk but not this market risk. By contrast, risks tied to a particular company or its operations are mitigated as you spread holdings across many firms, since problems at one company don’t affect all of them in the same way. So the risk that cannot be diversified away is the systematic, market-wide risk.

Systematic risk is the part of risk that comes from overall market factors that affect virtually all assets, such as changes in interest rates, inflation, recessions, or major geopolitical events. Because these forces move the entire market, simply holding a broader or more diverse set of securities cannot eliminate them. Even a well‑diversified portfolio will still be influenced by market-wide movements, so this risk remains as the non-diversifiable portion of return variability. The amount of risk tied to market movements is often described with beta, reflecting how a security or portfolio tends to move with the market; diversification can reduce idiosyncratic, or firm‑specific, risk but not this market risk. By contrast, risks tied to a particular company or its operations are mitigated as you spread holdings across many firms, since problems at one company don’t affect all of them in the same way. So the risk that cannot be diversified away is the systematic, market-wide risk.