What is Systematic Risk?
Systematic risk is a comprehensive risk impacting a whole market or market segment. It comes from macroeconomic factors outside of individual control and cannot be eradicated through diversification. It is crucial for all investments and encompasses unpredictable events.
Understanding Systematic Risk
Systematic risk is unpredictable and cannot be fully avoided. It can only be managed through hedging or asset allocation strategies. It includes broad factors like interest rate changes, inflation, economic downturns, and geopolitical conflicts, affecting the entire market. To manage this risk, diverse assets like fixed income, cash, and real estate should be included in portfolios as they react differently to these changes.
Types of Systematic Risk
Types of systematic risk include:
- Interest-Rate Risk: This arises from varying market interest rates affecting fixed-income instruments.
- Market Risk: This risk relates to changes in overall market security prices, especially during a stock market drop.
- Exchange Rate Risk: This results from variations in currency values affecting businesses involved in significant foreign exchange transactions.
- Political Risk: This risk is associated with political instability impacting government policies, regulations, and geopolitical events that affect business decisions.