Certified Management Accountant Practice Exam

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What type of risk does specific risk refer to?

Market risk that is unavoidable
Diversifiable risk associated with specific investees
Systematic risk across all investments
Risk that affects the entire economy

The correct answer is: Diversifiable risk associated with specific investees

Specific risk refers to the unique risk associated with individual investments or groups of investments, which can be diversified away to some extent through portfolio management. This type of risk is often tied to the performance of particular companies or sectors. For example, if a company faces issues that affect its profitability, such as poor management decisions or a product recall, this can create specific risk that impacts only that company or its stock, rather than the broader market. Investors can reduce specific risk by holding a diversified portfolio that includes a variety of assets from different sectors. This diversification helps mitigate the impact of any single investment's underperformance. In contrast, options that mention market risk or systematic risk refer to broader economic factors affecting all investments, which cannot be eliminated through diversification. Therefore, specific risk is best described as diversifiable risk associated with specific investees, making it the correct choice.