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Return, Risk and the Security
Market Line
Systematic and Unsystematic
Risk
Systematic risk
Risk that influences a large number of
assets. Also called market risk.
Unsystematic risk
Risk that influences a single company or
a small group of companies. Also called
unique or asset-specific risk.
Total risk = Systematic risk + Unsystematic risk
Diversification and Risk
• In a large portfolio, some stocks will go up in
value because of positive company-specific
events, while others will go down in value
because of negative company-specific events.
• Unsystematic risk is essentially eliminated by
diversification, so a portfolio with many assets
has almost no unsystematic risk.
• Unsystematic risk is also called diversifiable risk,
while systematic risk is also called
nondiversifiable risk.
The Systematic Risk Principle
• The systematic risk principle states that
the reward for bearing risk depends only
on the systematic risk of an investment.
• So, no matter how much total risk an asset
has, only the systematic portion is relevant
in determining the expected return (and
the risk premium) on that asset.
