Systematic and Unsystematic Risk

What this video covers

• Why systematic risk is called market risk or non-diversifiable risk, and why purchasing power risk, reinvestment risk, interest rate risk, market risk, and exchange rate risk (PRIME) can never be eliminated through diversification
• The three subtypes of unsystematic risk: business risk, financial risk, and security-specific liquidity risk, and which one is tied directly to company leverage
• Why asset allocation and diversification are not the same tool: asset allocation manages systematic risk across broad classes, while diversification eliminates unsystematic risk within a class
• How the correlation coefficient drives diversification benefit, why +1.0 gives zero benefit, and why -1.0 gives the maximum theoretical benefit
• The critical distinction between beta (measures systematic risk only) and standard deviation (measures total risk)
• Why two stocks in the same industry provide almost no diversification benefit due to high positive correlation
• The golden rule Sam the supervisor applies: for diversification benefits to begin, correlation must be less than +1.0