Which of the following statements about systematic risk is true?
It is nondiversifiable.
Systematic risk, also known as market risk, affects all investments across the market and cannot be eliminated through diversification. This type of risk is tied to broader economic factors such as interest rates, inflation, and political events, which impact the entire market rather than specific sectors or securities.
This statement accurately reflects the nature of systematic risk, as it encompasses risks that cannot be mitigated through diversification strategies. Since systematic risk affects all assets in the market, investors must accept this risk or use hedging strategies to manage it.
This statement is incorrect because managing a bond portfolio with low duration primarily addresses interest rate risk, a component of systematic risk. While it may reduce sensitivity to interest rate changes, it does not eliminate exposure to overall market risk, which remains systematic.
Purchasing emerging market stocks or bonds does not diversify systematic risk; instead, it may introduce additional risks related to geopolitical instability and economic volatility specific to those markets. Systematic risk remains inherent to the overall market and cannot be diversified away by focusing on specific asset classes.
This statement is also incorrect, as spreading an equity portfolio across different sectors does not eliminate systematic risk. While it may reduce unsystematic risk (sector-specific risk), systematic risk continues to impact all sectors simultaneously due to broader market influences.
Systematic risk is a fundamental characteristic of financial markets that affects all investments and is inherently nondiversifiable. Unlike unsystematic risk, which can be mitigated through diversification across various assets and sectors, systematic risk remains constant regardless of how an investor allocates their portfolio. Understanding this distinction is crucial for effective risk management in investment strategies.
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