Question

True or False

Higher risk equals higher returns only holds true for systematic risk,but not necessarily for unsystematic risk.

Why?

Answer 1

TRUE

Higher risk equals higher returns only holds true for systematic risk, but not necessarily for unsystematic risk because unsystematic risk can be diversified away. Unsystematic risk is the risk specific to the firms, industry, products, country etc. Unsystematic risk can be reduced by diversication in the portfolio. When unsystematic risk is diversified away, then there will be no risk. On the other hand, systematic risk is the risk of the market which is inherent and cannot be diversified away. So, higher is the systematic risk, higher is the return.