Question 26

Systematic risk is nondiversifiable.

Systematic risk refers to the inherent risk that affects the entire market or a significant portion of it, which cannot be eliminated through diversification. This risk is related to factors such as economic changes, political events, or natural disasters that impact all securities in the market.

A) It is nondiversifiable.

This statement is correct because systematic risk affects all assets and cannot be mitigated by diversifying a portfolio. It represents risks that are inherent to the entire market, such as inflation or interest rate changes, which cannot be avoided through diversification.

B) It is diversifiable by managing a bond portfolio with low duration.

This statement is incorrect. While managing a bond portfolio with low duration may reduce interest rate risk specific to bonds, it does not eliminate systematic risk, which affects all asset classes. Therefore, this option misrepresents the nature of systematic risk.

C) It is diversifiable by purchasing emerging market stocks or bonds.

This statement is also incorrect. Investing in emerging market stocks or bonds introduces additional risks, including market and political risks specific to those regions, but it does not eliminate systematic risk. In fact, it may increase exposure to broader market risks.

D) It is diversifiable by spreading an equity portfolio across different sectors in the market.

This statement is incorrect. While spreading an equity portfolio across different sectors can reduce unsystematic risk, it does not mitigate systematic risk, which impacts all sectors simultaneously. Therefore, diversification among sectors does not address the core issue of systematic risk.

Conclusion

The correct answer, that systematic risk is nondiversifiable, highlights its nature as a market-wide risk that cannot be mitigated through diversification strategies. All other options incorrectly suggest methods of diversification that do not address the fundamental characteristics of systematic risk, reinforcing the understanding that it is inherent to the market as a whole.