What are the two components of total risk? Which component is part of the risk-return relationship?...

What are the two components of total risk? Which component is part of the risk-return relationship? Why?

(Please thoroughly explain the the 2 components firm-specific risk and market risk. )

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Expert Solution

Firm specific risk is also called as unsystematic risk. This is a risk which is uniquely present for a firm or an organization. Eg. Litigation, labour strikes etc. This kind of risk can be eliminated by way of diversification.

Market risk is also called as systematic risk. This is that risk which is considered by investors while investing in the market. The bestest way to measure the amount of risk involved in the market is to look at the investment's beta. beta shows the volatility as it correlates with market volatility. Therefore a beta which is greater than one indicates that the investment has more market risk involved. This market risk is an overall risk that occurs from things like natural disasters, governmental policies and regulations etc.

Market risk is considered to be risk return relationship. It is generally known that higher the return, higher the risk. However it is not conclusive that if the risk is higher then return is also higher. The return depends on various fators.

jeff jeffy answered 3 months ago

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