Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

What does systematic risk refer to?

1. Risk due to individual financial assets

2. Risk from market-wide economic conditions

3. Risk from specific sectors of the economy

4. Risk originated from geopolitical events

The correct answer is: Risk from market-wide economic conditions

Systematic risk refers to the risk inherent to the entire market or a specific segment of the market, which cannot be eliminated through diversification alone. This type of risk is often associated with broader economic factors that affect the entire market, such as changes in interest rates, inflation, political instability, or economic recessions. It represents the impact of market-wide events on the performance of all assets within the market. The correct option highlights that systematic risk arises from market-wide economic conditions, making it a fundamental concept for understanding how external factors can influence investments regardless of the individual assets involved. Because systematic risk affects nearly all securities in the market, it is typically measured by beta, which reflects the sensitivity of an asset's returns to movements in the overall market. In contrast, other options represent different types of risks. Individual financial assets may be subject to unsystematic risk, which can be reduced through diversification. Risks associated with specific sectors or crises like geopolitical events may also lead to market disruptions, but they do not encompass the broader, uniform risk affecting the entire market structure in the way that systematic risk does.