Canadian Securities Course (CSC) Level 2 Practice Exam

Which risk factor cannot be reduced through diversification in an investment portfolio?

1. Liquidity risk

2. Political risk

3. Business risk

4. Systematic/market risk

The correct answer is: Systematic/market risk

The correct answer highlights that systematic or market risk cannot be mitigated through diversification in an investment portfolio. Systematic risk encompasses the inherent risk that affects the entire market or a broad range of assets. This includes factors such as economic fluctuations, interest rate changes, inflation, and geopolitical events, all of which influence the market as a whole, regardless of the individual assets held in a portfolio. Diversification is an effective strategy for minimizing unsystematic risk, which is specific to individual securities or sectors. By holding a variety of assets, investors can reduce the impact of any single investment's poor performance. However, since systematic risk impacts all securities simultaneously, diversification does not provide a safeguard against these broader market movements. The other risk factors listed in the question can be somewhat addressed through diversification. Liquidity risk pertains to the ease of buying or selling an asset without affecting its price; while diversification might not eliminate it, spreading investments can help in managing liquidity concerns. Political risk relates to the uncertainties arising from governmental actions and can be diversified across different regions or countries. Business risk is specific to individual companies and can also be mitigated through owning a mix of investments in various industries.