Which one of the following is the best example of systematic risk?

Question

BlackTom AI · Accepted Answer

Systematic risk (also called market risk) is a macroeconomic or market-wide source of uncertainty that affects virtually all assets and cannot be eliminated through diversification. The Capital Asset Pricing Model (CAPM) measures this with beta; investors require a market risk premium to bear systematic risk.

1) Relevant concepts
- Systematic vs. unsystematic risk: systematic risk impacts the entire market (e.g., interest-rate changes, recessions, inflation); unsystematic (idiosyncratic) risk is firm- or industry-specific and can be diversified away.
- Diversification principle: only unsystematic risk can be reduced by holding a broad portfolio; systematic risk remains and is priced by markets.

2) Step-by-step reasoning
Step 1: Examine each option to see whether the event affects the whole market or only a part of it.
Step 2: "The price of lumber declines sharply" mainly affects construction, timber, and related industries — an industry-specific (unsystematic) shock.
Step 3: "A hurricane hits a tourist destination" is geographically and sector-specific, impacting local tourism, insurance, and property values — unsystematic.
Step 4: "The Federal Reserve increases interest rates" changes borrowing costs, discount rates, and macroeconomic conditions across the entire economy, affecting stocks, bonds, consumption and investment — clearly systematic.
Step 5: "The airline pilots of a firm go on strike" is a firm- or at most industry-specific operational disruption — unsystematic.

3) Intermediate calculations
- No numerical calculations are required; classification is qualitative based on breadth of impact.

4) Why the correct answer is correct
A Fed rate increase is a policy action that shifts fundamental financial conditions economy-wide: it raises discount rates used to value all future cash flows, alters aggregate demand, and affects credit-sensitive sectors broadly. Because it impacts the overall market and cannot be diversified away, it is the best example of systematic risk.

5) Why other options are incorrect
- Lumber price plunge: industry-specific (unsystematic).
- Hurricane at a tourist spot: local/sector shock (unsystematic).
- Airline pilots strike: firm- or industry-level operational issue (unsystematic).

Conclusion: The correct answer is "The Federal Reserve increases interest rates," matching the provided answer.

Which one of the following is the best example of systematic risk?Single choice

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