Define the terms systematic risk and unsystematic risk. Be sure to exp

Define the terms systematic risk and unsystematic risk. Be sure to explain the difference between the two. Which type of risk can be diversified away? How do we measure the remaining type of risk?

Evaluate the statement: “If we could just make our investment portfolio large enough, we could completely eliminate risk and earn a market portfolio rate of return with the risk of a risk-free investment.”
What will be an ideal response?

ANSWER

Answer: Systematic risk is risk that cannot be diversified away, is measured with beta, and is the risk that impacts all stocks in an economy. On the other hand, unsystematic or diversifiable risk CAN be diversified away. This is risk that is unique to the asset and can be eliminated when combined in a portfolio of risky assets. As for our statement, we CANNOT totally eliminate uncertainty of returns just by increasing the number of risky assets that make up the portfolio: although we can eliminate unnecessary or unsystematic risk, we cannot eliminate systematic risk through diversification. Therefore, we cannot realize a risk-free investment with greater than risk-free returns.