Explain the difference between systematic and unsystematic risk.

• A. Systematic risk affects the entire market; unsystematic risk affects a specific company or industry and can be mitigated by diversification
• B. Systematic risk can be diversified away; unsystematic cannot
• C. Both cannot be diversified
• D. Systematic risk only relates to bonds

Answer: (A)

This is about distinguishing market-wide risk from company- or industry-specific risk. Systematic risk affects the overall market; it comes from broad factors like economic growth, inflation, interest rates, and geopolitical events, so it moves with the market as a whole and cannot be avoided by picking different stocks. Unsystematic risk, on the other hand, is tied to a particular company or industry—things like a management change, a product failure, or a sector-specific disruption. Because this risk is not shared by all investments, it can be reduced through diversification by holding a wide mix of different assets.

So the statement that the market as a whole is affected by systematic risk, while a specific company or industry carries unsystematic risk that diversification can mitigate, captures the key distinction. For example, a broad market downturn hits many stocks at once (systematic risk), whereas the failure of one company’s product mainly hurts that company or its peers but not every other sector.