What distinguishes systematic risk from unsystematic risk?

• A. Systematic risk affects the entire market (beta); unsystematic risk is firm-specific and diversifiable.
• B. Systematic risk is company-specific and diversifiable.
• C. Unsystematic risk affects the entire market.
• D. They are the same and cannot be distinguished.

Answer: (A)

Systematic risk is market-wide and tied to factors that affect almost all assets, like economic shifts, interest rates, or inflation. Because these forces move many securities together, you can’t dodge them just by choosing different stocks; this risk is captured by beta—it describes how a security tends to move with the overall market. Unsystematic risk, on the other hand, comes from events specific to a single company or industry—things like a product recall, a leadership change, or a patent dispute. These idiosyncratic events don’t move in lockstep with the market, so holding a diversified portfolio tends to cancel out much of this risk. The key distinction, then, is that market-wide risk cannot be eliminated through diversification, while firm-specific risk can be reduced by diversification.