NASAA Series 66 Uniform Combined State Law ExaminationEconomic Factors and Business InformationMedium
A financial planner is reviewing a client's holdings and identifies a significant concentration in a single regional banking stock. The planner advises the client that this concentration exposes them to the risk of a downturn specifically affecting that region's economy or the banking sector. This type of risk, which can be reduced through geographical and sector diversification, is best described as:
- AMarket risk.
- BNonsystematic risk.
- CInterest rate risk.
- DSystematic risk.
Show answer & explanationAnswer & explanation
Correct answer: B. Nonsystematic risk.
Nonsystematic risk (also known as specific risk or diversifiable risk) is unique to a particular company, industry, or region. A concentration in a single regional banking stock exposes the client to risks specific to that region or banking sector, which can be mitigated by diversifying across different regions and industries.
Why the other options are wrong
- A. Market risk is another term for systematic risk. The described risk is more specific than broad market risk.
- C. Interest rate risk primarily affects fixed-income securities and is not the core issue with a concentrated regional equity holding.
- D. Systematic risk affects the entire market and cannot be diversified away. A regional downturn is not necessarily systematic.
Nonsystematic Risk (Diversifiable Risk)
Risk that is unique to a specific company, industry, or geographical region and can be reduced or eliminated through diversification.
- Also known as specific risk or unsystematic risk.
- Examples: regional economic downturn, sector-specific issues.
- Mitigated by diversifying across various assets, industries, and geographies.
Memory trick: Nonsystematic: Niche, Narrow, Neutralized by New Holdings.