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Tuesday, November 17, 2009

Identify and contrast diversifiable and nondiversifiable risks.

Diversifiable Risk may be defined as the portion of an asset's risk that can be eliminated through diversification, also called Unsystematic Risk or controllable risk. It results from the occurrence of random events such as labor strikes, lawsuits, or loss of key accounts. This type of risk is unique to a given asset. Business, liquidity, and default risks fall into this category. It is assumed that any investor can create a portfolio in which this type of risk is completely eliminated through diversification.

Non-diversifiable risk, also called systematic risk or market risk, is risk of an investment asset (bond, real estate, share/stock, etc.) that cannot be reduced or eliminated through diversification or adding that asset to a diversified investment portfolio. Market or systemic risks are non-diversifiable risks. The value of investments may decline over a given time period simply because of economic changes or other events that impact large portions of the market. Asset allocation and diversification can protect against non-diversifiable risk because different portions of the market tend to under perform at different times.

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