R02 Systematic, non-systematic and systemic risk: free practice questions

1. Question 1 of 5

   Global equity markets fell sharply during the COVID-19 pandemic. Which type of risk does this illustrate?

   Option A: Operational riskOption B: Shortfall riskOption C: Non-systematic riskOption D: Systematic risk

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   The answer is D: Systematic risk

   Systematic (market) risk is the risk of events that change expected returns across the stock market generally, as in the 2008 financial crisis and the pandemic.

   Why the other options are wrong

   A

   Operational risk arises from the investment process itself.

   B

   Shortfall risk is about missing a financial target.

   C

   Non-systematic risk is specific to one company or sector.

2. Question 2 of 5

   What is systemic risk?

   Option A: The risk of a computer systems failure at an investment management firmOption B: The risk that affects returns on all the shares in a marketOption C: The risk of a shock causing a chain reaction through the financial systemOption D: The risk unique to one company's shares

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   The answer is C: The risk of a shock causing a chain reaction through the financial system

   Systemic risk is the risk of disruption to the financial system, triggered by an economic shock or institutional failure, causing a chain reaction of price volatility, significant losses or market failure.

   Why the other options are wrong

   A

   That's operational risk.

   B

   That's systematic risk, which sounds similar but differs.

   D

   That's non-systematic risk.

3. Question 3 of 5

   Which UK body identifies, monitors and acts to reduce systemic risks to the financial system?

   Option A: The Financial Services Compensation SchemeOption B: The Bank of England's Monetary Policy CommitteeOption C: The Bank of England's Financial Policy CommitteeOption D: The Debt Management Office

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   The answer is C: The Bank of England's Financial Policy Committee

   The Financial Policy Committee (FPC) of the Bank of England identifies, monitors and takes action to remove or reduce systemic risks, protecting the resilience of the UK financial system.

   Why the other options are wrong

   A

   The FSCS compensates customers of failed firms.

   B

   The MPC sets interest rates to meet the inflation target.

   D

   The DMO manages Government borrowing through gilts.

4. Question 4 of 5

   Into which two types does modern portfolio theory categorise risk?

   Option A: Systemic and operational riskOption B: Political and regulatoryOption C: Systematic and non-systematicOption D: Capital risk and income risk

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   The answer is C: Systematic and non-systematic

   MPT splits risk into systematic (market) risk, which can't be diversified away, and non-systematic (investment-specific) risk, which can.

   Why the other options are wrong

   A

   These are other risk types, not MPT's two categories.

   B

   These are specific risks, not MPT's categories.

   D

   These are other ways to group risks.

5. Question 5 of 5

   A pharmaceutical firm's shares drop after its main drug fails trials. How could an investor have limited the effect on their portfolio?

   Option A: By holding shares in many companies and sectorsOption B: By buying more shares in the firm after the fallOption C: By switching from shares into longer-dated giltsOption D: By holding only pharmaceutical shares

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   The answer is A: By holding shares in many companies and sectors

   This is investment-specific risk. Diversifying across companies and sectors means a problem at one has less impact on the whole portfolio.

   Why the other options are wrong

   B

   That adds to the concentration.

   C

   That changes asset class but isn't how specific risk is reduced.

   D

   Concentration in one sector increases exposure to this kind of event.

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