Finance – Components of Total Risk

Total Risk 1. Systematic Risk2. Unsystematic Risk
Standard deviation of an asset Measures systematic and unsystematic risk
Systematic Risk AKA 1. non-diversifiable risk;2. market risk
Systematic Risk – Simultaneously affects many different securities- Cannot be eliminated through diversification- Fully diversified portfolio still has volatility of approx 20%, being almost entirely systematic risk
Systematic Risk Examples – Interest rate fluctuations- Inflation- Major catastrophes
Unsystematic Risk AKA 1. diversifiable risk2. unique risk3. company-specific risk
Unsystematic Risk – Affects only a select number of securities- Can be eliminated through diversification- Can impact a number of securities or an industry
Unsystematic Risk Examples – Loss of key employees- Exposure to fraud at top levels- New product lines failing- Increase in costs of specific inputs
Diversification The act of investment in a variety of different assets rather than just one or two similar assets

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