Differentiate between systematic and unsystematic risk. Which statement is correct?

• A. Systematic risk affects a broad market and cannot be diversified away; unsystematic risk is specific to a company/industry and can be reduced via diversification
• B. Systematic risk can be diversified away; unsystematic cannot
• C. Both systematic and unsystematic risks can be fully diversified away
• D. Neither systematic nor unsystematic risk can be diversified away

Answer: (A)

Systematic risk is the risk that affects the entire market or large swathes of it, driven by macro factors like economic growth, interest rates, inflation, and geopolitical events. Because these factors move many assets together, systematic risk cannot be eliminated just by holding more securities. Unsystematic risk, in contrast, is tied to a specific company or industry—things like a product failure, management changes, or a sector-specific regulation. This type of risk can be reduced by diversification, since different companies and sectors don’t move in perfect lockstep.

So, the statement that best fits is that broad-market risk remains even after diversification, while company- or industry-specific risk can be reduced through diversification. The other options are inconsistent with how diversification works: they either claim systematic risk can be diversified away, or that neither type can be diversified away, or that both can be fully eliminated.