What is the difference between systematic risk and unsystematic risk?

The distinction between systematic risk and unsystematic risk is fundamental in finance, particularly in the context of investing and portfolio management. Systematic risk refers to the type of risk that is inherent to the entire market or a particular segment of the market. This includes factors such as economic changes, political events, or natural disasters that can impact all assets to some degree. Because systematic risk affects the overall market, it cannot be eliminated through diversification; it is unavoidable and affects all investments in a similar manner.

On the other hand, unsystematic risk is specific to a particular company or industry. This type of risk arises from factors that are unique to that entity, such as management decisions, product recalls, or competitive positioning. Because unsystematic risk is not correlated with market movements, it can often be mitigated or eliminated through diversification. Investors can reduce their exposure to unsystematic risk by spreading their investments across various assets or sectors.

Therefore, the correct understanding is that systematic risk affects the entire market, while unsystematic risk is isolated to individual assets, making option B the accurate representation of the differences between the two types of risk.