Systematic vs. Nonsystematic Risk

The exam usually tests this through a mitigation question: it names a risk, then asks whether adding positions fixes it. The “tell” is the phrase “reduce by diversification.” Map the named risk to a category first — interest-rate and inflation risk are systematic (also called market or undiversifiable risk); business, credit, regulatory, legislative, and liquidity risk are nonsystematic (unsystematic or diversifiable). Then the answer follows: more holdings cure only the nonsystematic side. (Treatment of currency and political/event risk is provider-specific — some banks call them systematic, others diversifiable across countries — so weigh those by context.)

The classic trap is credit risk, which feels market-wide but is issuer-specific and therefore nonsystematic — diversifying across issuers genuinely lowers it, while broad market risk stays no matter how many stocks you hold. A second trap: students “fix” market risk by buying more equities, but the cure is hedging or asset allocation, not breadth. Watch for liquidity risk mislabeled as systematic; it is nonsystematic too. Memory hook: systematic = the whole system moves together, so spreading out cannot escape it.