In broad terms, why is some risk diversifiable? Why are some...

Name: Problem 1, Chapter 13: Fundamentals of Corporate Finance
Uploaded: 2020-07-09T04:57:26-08:00
Duration: 37 s
Channel: Achintya Suden
Description: In broad terms, why is some risk diversifiable? Why are some risks nondiversifiable? Does it follow that an investor can control the level of unsystematic risk in a portfolio, but not the level of systematic risk?

In broad terms, why is some risk diversifiable? Why are some risks nondiversifiable? Does it follow that an investor can control the level of unsystematic risk in a portfolio, but not the level of systematic risk?

Key Concepts

Control of Portfolio Risk

Investors have the ability to control unsystematic risk through diversification by including a wide range of assets that do not move in sync with each other. However, systematic risk, which impacts the overall market, cannot be controlled within a portfolio; it must be managed through other measures such as hedging, asset allocation strategies, or accepting a certain level of market exposure.

Diversification

Diversification is the investment strategy of spreading investments across various assets, sectors, or regions in order to reduce exposure to any single asset's performance. By doing so, investors can minimize the impact of individual asset fluctuations on the overall portfolio, particularly those caused by factors that affect only specific companies or industries.

Unsystematic Risk

Unsystematic risk refers to the risks that are unique to a specific company or industry, such as management decisions, competitive pressures, or operational issues. Because this type of risk is not correlated across the market, it can be reduced or even eliminated through diversification. This allows investors to manage and control the level of unsystematic risk within their portfolio.

Systematic Risk

Systematic risk is the risk inherent to the entire market or economy, arising from factors such as economic recessions, political instability, or natural disasters. This risk, which affects all investments to varying degrees, is nondiversifiable because it relates to broad, pervasive factors that cannot be mitigated simply by diversifying investment holdings.

Transcript

Please give Ace some feedback