Question

In general, the larger a portfolio (in terms of number of assets) the lower its non-systematic...

In general, the larger a portfolio (in terms of number of assets) the lower its non-systematic risk.”
a. Define systematic risk and non-systematic risk, and briefly explain their difference.​​​​​​​​​
b. Do you agree or disagree with the above statement? Justify your answer. ​​​​​​​
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Answer #1

a) Systematic risk-it is a risk which is based upon the market risk for operating into a particular market and it is related with macro factors as inflation, interest rate, political instability etc.

Systematic risk is best represented by beta and it is believed that systematic risk cannot be completely eliminated because there would always be risk associated to investment related to particular market because one can never hedge himself against macro factors.

unsystematic risk is a risk associated with a particular firm or industry as these are highly controllable in nature through diversification of the portfolio and it could be even eliminated to a very large extent. It is the risk related to to change in demand pattern or supply patterns of a particular industry.

Difference between both type of risk is that systematic risk is risk related to macro factors, whereas unsystematic risk is related to micro factors.

Systematic risk can never be eliminated through diversification but unsystematic risk can be reduced to a very large extent through diversification.

b) I do not agree with this statement completely because when there is a wide number of stocks which is present in the portfolio, the risk is not completely eliminated .

Risk can only be diversified through proper allocation of of resources into selected number of companies which are representative of various sectors. Selection of a large number of stocks does not reduce the nonsystematic risk because it can even mean that selection of stocks would be from same sector and it could even magnify the risk because there is not proper allocation and diversification so there should be selection of a limited number of stocks which are representative of diverse sectors of the economy, through which we can diversify our risk to a very large extent.

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