Correct Answer:
B. Unsystematic risk
Investment risk can be broadly categorized into two main types: systematic and unsystematic risk. Unsystematic risk, also known as specific risk or diversifiable risk, is unique to a particular company, industry, or asset. It arises from factors such as management decisions, labor strikes, product recalls, or specific operational issues. This type of risk can be significantly reduced or virtually eliminated through diversification, which involves investing in a variety of assets across different companies and industries.
- B: Unsystematic risk is the correct answer because diversification, by combining different assets, helps to average out the unique risks associated with individual investments.
- A: Systematic risk, also known as market risk, is inherent to the entire market or economy and affects all investments to some degree. It cannot be eliminated through diversification.
- C: Market risk is another term for systematic risk, encompassing broad economic factors like recessions or inflation.
- D: Interest rate risk is a component of systematic risk, specifically affecting the value of fixed-income securities due to changes in prevailing interest rates. It is not diversifiable.
Understanding this distinction is crucial for constructing a well-balanced and risk-managed investment portfolio.