What is the difference between systematic and unsystematic risk?

Systematic risk and unsystematic risk are fundamental concepts in finance that help investors understand the different types of risks associated with investments.

Systematic risk, also known as market risk, refers to the risk that affects the entire market or economy rather than just a particular specific industry or stock. This type of risk arises from factors such as economic recessions, interest rate changes, inflation, and geopolitical events. Since these factors impact a wide range of investments, they are not easily mitigated through diversification. Investors cannot eliminate systematic risk through portfolio diversification because it influences all investments in the market.

On the other hand, unsystematic risk is specific to a certain company or industry. This type of risk can arise from events like a management scandal, product failure, or changes in industry regulations. Unlike systematic risk, unsystematic risk can be significantly reduced or eliminated through diversification—holding a variety of investments helps to spread out and mitigate this risk, as not all assets will react in the same way to specific events affecting the market.

Therefore, the recognition that systematic risk affects the entire market while unsystematic risk pertains to specific companies underscores why the distinction in the correct answer is crucial for investors when making decisions. Understanding these two types of risks can better inform