2.3.1. Types of Systematic Risk
Market. Market risk is the risk that economic, political, or market conditions, such as a war, credit crunch, natural disaster, interest rate change, or economic slump, will cause an entire class of securities—stocks, for example—to fall in price. A list of financial markets may be found near the beginning of Appendix A. Because market risk affects an entire asset class, it is not possible to eliminate this risk through diversification within an asset class (by picking stocks from different industry sectors, for example).
While all stocks (and for that matter, all bonds) are exposed to market risk, not every stock is exposed to market risk to the same extent. The beta coefficient of a stock (also called beta) indicates the stock’s relative susceptibility to market risk. Stocks with a beta coefficient of less than 1 tend to fluctuate in value less than the market as a whole and are thus less exposed to market risk than stocks with a higher beta.
Inflation. Inflation erodes purchasing power: a dollar today can buy more than a dollar in the future as the price of goods and services rises. Inflation risk, also called purchasing power risk, is the risk that investment returns will be worth less than expected in the future because of diminishing purchasing power. The most commonly referenced measure of inflation is the Consumer Price Index, which measures the price of a “basket” of goods and services purchased by the average consumer. Inflation risk t