Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

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Which of the following best illustrates a potential concern related to systematic risk?

Individual company bankruptcy
Market-wide economic downturns
Failures in specific industries
Fluctuations in one stock's price

The correct answer is: Market-wide economic downturns

In the context of systematic risk, market-wide economic downturns best illustrate a potential concern because systematic risk refers to the risk inherent to the entire market or market segment. This type of risk affects all investments and cannot be eliminated through diversification. When an economic downturn occurs, it typically results in widespread declines in asset values, affecting virtually all securities rather than just individual stocks or sectors. Individual company bankruptcy represents unsystematic risk, as it pertains specifically to a single entity and does not affect the broader market. Similarly, failures in specific industries also relate to unsystematic risk, as they primarily impact companies within that particular sector. Fluctuations in one stock's price are indicative of idiosyncratic risk affecting that specific company rather than the overall market. Therefore, market-wide economic downturns align with systematic risk, highlighting its pervasive nature across investments.