Question

9) If an investor plans to add a stock to a well-diversified portfolio, the investor should first consider the ________ risks of that additional stock.

A) expected total

B) historical total

C) systematic

D) idiosyncratic

E) firm-specific

Answer 1

The correct answer is systematic

There are two types of Risk

Systematic Risk - It is the volatility of a stock on account of economy wide factors. It affects all stocks in the same direction with unequal sensitivity. It is the risk which is inherent to the market and it cannot be avoided through diversification.

Unsystematic Risk - It is the volatility of a stock on account of internal company specific factors. This risk can be avoided through diversification. The greater the number of stocks in the portfolio the greater is the chance of Unsystematic Risk getting cancelled out. Idiosyncratic and firm-specific is the Unsystematic risk.

Investors are exposed to a variety of risks when investing in securities. Some of the risks are associated with economic events that can be linked to risk and return. The investor should first consider the systematic risks of that additional stock as Systematic Risk or Market risk cannot be eliminated even in a well-diversified portfolio.