Question

Inflation, war, political upheaval, and other broad economic events cause:
a. business specific risk
b. diversifiable risk
c. non-diversifiable unsystematic risk
d. market risk

Answer 1

Inflation, war, political upheaval, and other broad economic events cause :-

Both (c) & (d) i.e. Non-diversifiable unsystematic risk & market risk

Investors confront two main types of risk when investing. They are :- systematic risk & unsystematic risk.
The first risk is undiversifiable, and is known as Undiversifiable risk or Systematic or Market risk. This type of risk is associated with every company. Common causes include inflation rates, exchange rates, political instability, war, and interest rates. This type of risk is not specific to a particular company or industry, and it cannot be eliminated or reduced through diversification—it is just a risk investors must accept.
Systematic risk affects the market in its entirety, not just one particular investment vehicle or industry. Systematic risk is inherent to the market as a whole, reflecting the impact of economic, geo-political and financial factors. Investors can somewhat mitigate the impact of systematic risk by building a diversified portfolio.

Market risk is the risk that an investor faces due to the decrease in the market value of a financial product arising out of the factors that affect the whole market and is not limited to a particular financial commodity. Often called a systematic risk, market risk arises because of uncertainties in the economy, political environment, natural or man-made disasters or recession.

Market risk is generally expressed in annualized terms, either as a fraction of the initial value (e.g. 6%) or an absolute number (e.g. $6). Market risk contrasts with specific risk, also known as business risk or unsystematic risk, which is tied directly with a market sector or the performance of a particular company. In other words, market risk refers to the overall economy or securities markets, while specific risk involves only a part.

There are several standard market risk factors, including:

• Equity Risk: the risk that share prices will change.
• Commodity Risk: the likelihood that a commodity price, such as that of a metal or grain, will change.
• Currency Risk: the probability that foreign exchange rates will change.
• Interest Rate Risk: the risk that interest rates will go up or down.
• Inflation Risk: the risk that overall rises in prices of goods and services will undermine the value of money, and probably adversely impact the value of investments.

Risk can be reduced to some extent if an investor diversifies his/her investment portfolio. However, it is impossible to eliminate all market risks/systematic risks/undiversifiable risks.

Most market risks are not possible to prevent or foresee. Natural disasters, such as hurricanes, volcanic eruptions and earthquakes can strike at any time and may affect the value of the investments. Other sources of market risk include terrorist attacks, political instability, recessions, and trade embargoes.

If an investor wants to know how much systematic risk a particular security, fund or portfolio has, he/she can look at its beta, which measures how volatile that investment is compared to the overall market. A beta of greater than 1 means the investment has more systematic risk than the market, while less than 1 means less systematic risk than the market. A beta equal to one means the investment carries the same systematic risk as the market.

For example :- The stock market has responded to the COVID-19 pandemic with worrying volatility, as traders have panic-sold out of fear. As a result of the recent turmoil, the market-wide circuit-breakers that attempt to prevent panic-trading, have been triggered four times only in March.