How is risk triggered by events such as lawsuits, strikes, and unsuccessful marketing campaigns classified____________?
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Answer: C. Diversifiable risk
Explanation
Diversifiable risk stems from firm-specific events such as labor strikes, lawsuits, or product recalls. Because these events affect only individual companies, their impact can be neutralized through portfolio diversification. Investors are not compensated with higher expected returns for bearing this type of company-specific risk. Diversifiable risk is also widely referred to in financial literature as unsystematic or specific risk. Modern portfolio theory demonstrates that holding a sufficient number of unrelated stocks eliminates this risk component. It contrasts with macroeconomic factors that simultaneously influence the entire broader financial marketplace.
Individual retail investors protect their savings from single-stock disasters by building diversified mutual funds. For example, a lawsuit against one pharmaceutical company will not ruin a portfolio holding fifty different stocks. Understanding this distinction helps portfolio managers focus their risk management efforts on systematic factors. Stock risk is a vague term that does not specifically categorize the nature of firm-specific events. Portfolio risk encompasses both systematic and unsystematic risks rather than just company-specific events. Market risk affects all securities simultaneously and cannot be eliminated through simple asset diversification.
- Subject
- Accounting and Finance
- Category
- Finance
- Topic
- —
- Difficulty
- medium
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