An investment advisor is conducting a risk review for a client holding a broadly diversified equity portfolio. Which of the following statements regarding systematic risk in this portfolio are CORRECT?
- Systematic risk affects the broader market and cannot be eliminated through traditional asset diversification alone.Answer
- BReallocating equity assets entirely into long-term corporate bonds eliminates interest rate risk from the portfolio.
- Investors can hedge against broad market systematic risk by purchasing index put options.Answer
- DSystematic risk primarily measures the likelihood that a specific corporate issuer will default on its debt obligations.
Answer
The correct statements are that systematic risk affects the broader market and cannot be eliminated by diversification alone, and that broad market systematic risk can be hedged using index put options.
Systematic risk affects the overall market and economy, making asset diversification ineffective at eliminating it. However, market participants can manage systematic risk by hedging portfolio value with derivative products like index put options. Conversely, shifting capital to long-term bonds increases interest rate risk, and issuer default risk is a business/credit risk specific to single issuers rather than a systematic risk.
Step-by-Step Solution
Key Concept
Systematic risk influences the entire financial system, cannot be eliminated by diversification, but can be hedged with market index options.