Canadian Securities Course (CSC) Level 2 Practice Exam

What type of risk cannot be diversified away in an investment portfolio?

1. Default risk

2. Foreign investment risk

3. Liquidity risk

4. Political risk

The correct answer is: Default risk

The risk that cannot be diversified away in an investment portfolio is typically referred to as systematic risk. Among the options presented, default risk is a specific type of risk mostly associated with individual securities, particularly fixed income instruments. While an investment portfolio can certainly include multiple securities that expose it to default risk, effective diversification can mitigate the impact of a single asset defaulting. Foreign investment risk, liquidity risk, and political risk all relate to broader external factors and can similarly be mitigated through a diversified portfolio. For instance, geopolitical events (political risk) or varying levels of liquidity in different markets can affect a portfolio, but these factors are often accounted for through a mix of asset classes and global diversification. In contrast, the correct answer represents a risk characteristic that inherently affects the entire market or a significant portion of it. This includes factors like changes in interest rates, inflation, or economic downturns. These types of risks cannot be avoided through diversification because they impact all investments within a market. Therefore, the nature of the question points toward an understanding of systematic risk rather than the specific risks associated with individual securities.