Define systematic and unsystematic risk. What method is used to measur

Define systematic and unsystematic risk. What method is used to measure a firm’s market risk?

What will be an ideal response?

ANSWER

We can divide the total risk (total variability) of our portfolio into two types of risk: 1. company-unique risk, or
unsystematic risk, and 2. market risk, or systematic risk. Company-unique risk might also be called diversifiable risk
in that it can be diversified away. Market risk is nondiversifiable risk; it cannot be eliminated through random
diversification. Events that affect our portfolio now are not so much unique events as changes in the general economy,
major political events, and societal changes. Examples include changes in interest rates, changes in tax legislation that
affect all companies, or increasing public concern about the effect of business practices on the environment. Our
measure of risk should, therefore, measure how responsive a stock or portfolio is to changes in a market portfolio, such
as the New York Stock Exchange or the S&P 500 Index. Beta (B) in investor jargon, and it measures the average
relationship between a stock’s returns and the market’s returns.