Unsystematic Risks

Unsystematic risk is the risk specific to a particular company, industry, or issuer. Also called diversifiable risk, company-specific risk, or non-systematic risk.

• CAN be reduced or eliminated through diversification - holding securities across different companies, industries, and asset classes
• The amount of unsystematic risk in a portfolio depends on the number of securities held and the correlation between them

The NASAA exam outline explicitly names four unsystematic risks: credit risk, legal/regulatory risk, financial risk, and issuer-specific risk.

Credit Risk (Default Risk)

The risk that a bond issuer fails to make interest or principal payments.

• Also called default risk
• Measured by credit ratings (Moody's, S&P, Fitch)
• U.S. Treasuries have virtually no credit risk

Financial Risk

The risk arising from a company's use of debt (leverage).

• Higher debt-to-equity ratios increase the likelihood of financial distress or default

Legal/Regulatory Risk

The risk that changes in laws, regulations, or legal actions negatively affect a specific company or industry.

• Examples: new environmental regulations on one sector, lawsuits against a company

Issuer-Specific Risk

Issuer-specific risk (business risk) is the risk tied to a particular company's operations, management, products, competitive position, or business model.

• Can be reduced: By diversifying across many issuers so no single company's failure devastates the portfolio
• Represents the uncertainty about a company's operating performance
• Examples: product recalls, labor disputes, loss of market share, failed product launches, technology obsolescence

Why is this important? A company can have excellent operations (low business risk) but still fail because it borrowed too much money (high financial risk). Financial risk measures the debt burden, not the quality of the business itself.

Other Unsystematic Risks

While the four risks above are specifically named in the NASAA exam outline, other unsystematic risks commonly appear on the exam:

Liquidity Risk: The risk of being unable to sell an investment quickly without a significant price concession. Illiquid examples include direct participation programs (DPPs), non-traded real estate investment trusts (REITs), hedge funds, and restricted securities.

Political Risk: The risk that government actions or political instability in a specific country affect investments tied to that country. This is distinct from broad geopolitical risk (which is systematic) - political risk targets specific countries or regions.

Call Risk: The risk that an issuer redeems a callable bond before maturity, forcing the investor to reinvest at potentially lower rates.

Exam Tip: Gotchas

• Political risk is unsystematic; geopolitical risk is systematic. Political risk targets a specific country's policies (e.g., nationalization in one emerging market). Geopolitical risk sweeps the broader global market (e.g., war between major powers). The exam tests this distinction.

Systematic vs. Unsystematic Risk Comparison

Summary of Unsystematic Risks

Exam Tip: Gotchas

• Credit risk is unsystematic (specific to an issuer) even though multiple issuers can default in a recession. Interest rate risk is systematic because rate changes affect all fixed-income securities simultaneously. If the question says "can be reduced through diversification," the answer is unsystematic risk.