Study guide
3.2 Unsystematic (Company-Specific) Risk
Series 65 Uniform Investment Adviser Law
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1 Introduction
About the Series 65 How to Use This Guide
2 Chapter 1: Economic Factors & Business Cycles
1.1 Business Cycles 1.2 Monetary Policy 1.3 Fiscal Policy 1.4 Inflation & Deflation 1.5 Interest Rates & Yield Curves 1.6 Global Economic Factors
3 Chapter 2: Financial Reporting & Analytical Methods
2.1 Financial Statements Overview 2.2 Accounting Fundamentals 2.3 SEC Filings & Annual Reports 2.4 Financial Ratios 2.5 Time Value of Money 2.6 IRR and NPV 2.7 Descriptive Statistics
4 Chapter 3: Types of Risk
3.1 Systematic (Market) Risk 3.2 Unsystematic (Company-Specific) Risk 3.3 Interest Rate & Reinvestment Risk 3.4 Inflation & Currency Risk 3.5 Liquidity Risk & Opportunity Cost 3.6 Risk Measurement & Portfolio Theory
5 Chapter 4: Cash Equivalents & Fixed Income Securities
4.1 Cash & Cash Equivalents 4.2 Treasury Securities 4.3 Agency Securities 4.4 Corporate Bonds 4.5 Municipal Bonds 4.6 Bond Pricing & Yields
6 Chapter 5: Equity Securities
5.1 Common Stock 5.2 Preferred Stock 5.3 Shareholder Rights & Corporate Actions 5.4 Equity Valuation Methods 5.5 ADRs, REITs & Other Equity Securities
7 Chapter 6: Pooled Investments
6.1 Mutual Funds 6.2 Mutual Fund Costs & Fees 6.3 Exchange-Traded Funds (ETFs) 6.4 Closed-End Funds & UITs 6.5 Hedge Funds & Private Equity
8 Chapter 7: Derivatives, Alternative Investments & Insurance Products
7.1 Options Basics 7.2 Options Strategies 7.3 Alternative Investments 7.4 Annuities 7.5 Life Insurance Products
9 Chapter 8: Client Types & Profiles
8.1 Individual Clients 8.2 Business Entity Clients 8.3 Trusts & Estates 8.4 Accredited & Qualified Investors 8.5 Suitability & Know Your Customer
10 Chapter 9: Portfolio Theory & Capital Markets
9.1 Modern Portfolio Theory 9.2 Capital Asset Pricing Model (CAPM) 9.3 Efficient Market Hypothesis 9.4 Risk & Performance Measures 9.5 Asset Allocation
11 Chapter 10: Portfolio Management Strategies
10.1 Investment Styles 10.2 Portfolio Management Techniques 10.3 Fixed Income Strategies 10.4 Return Calculations
12 Chapter 11: Tax Considerations & Retirement Planning
11.1 Capital Gains & Investment Taxes 11.2 Retirement Plans Overview 11.3 Individual Retirement Accounts (IRAs) 11.4 Education Savings Plans 11.5 Distributions & RMDs
13 Chapter 12: ERISA, Special Accounts & Performance Measures
12.1 ERISA Requirements 12.2 Special Account Types 12.3 Performance Measures & Reporting 12.4 QDROs & Special Situations
14 Chapter 13: Regulation of Investment Advisers
13.1 Investment Advisers Act of 1940 13.2 Registration Requirements 13.3 Recordkeeping Requirements 13.4 Custody Requirements 13.5 Exempt Reporting Advisers
15 Chapter 14: Regulation of Investment Adviser Representatives
14.1 IAR Definition & Requirements 14.2 Registration & Post-Registration 14.3 IARs of Federal Covered Advisers
16 Chapter 15: Regulation of Broker-Dealers & Agents
15.1 Broker-Dealer Definition 15.2 Agent Registration 15.3 Regulation Best Interest
17 Chapter 16: Securities Registration & Exemptions
16.1 Uniform Securities Act 16.2 Securities Registration Methods 16.3 Exempt Securities 16.4 Exempt Transactions
18 Chapter 17: Communications & Client Relationships
17.1 Advertising Rules 17.2 Social Media & Electronic Communications 17.3 Client Agreements & Disclosure 17.4 Proxy Voting & Other Obligations
19 Chapter 18: Ethics & Fiduciary Obligations
18.1 Fiduciary Duties 18.2 Prohibited Practices 18.3 Senior & Vulnerable Adult Protection 18.4 AML & Compliance Programs
3.2 Unsystematic (Company-Specific) Risk
Key Takeaways Explain This Topic AI
Unsystematic risk affects specific companies or industries.
It can be reduced through diversification.
Business, financial, and regulatory risks are unsystematic.
Concentration increases unsystematic risk.
Diversification across sectors lowers company-specific risk.
Last updated: October 2026
Unsystematic risk (also called diversifiable risk, specific risk, unique risk, or idiosyncratic risk) is risk that affects a particular company, industry, or sector. Unlike systematic risk, unsystematic risk can be reduced or eliminated through proper diversification.
The Key Distinction
- Feature Systematic Risk Unsystematic Risk
- Affects Entire market Specific companies/industries
- Diversifiable? No Yes
- Measured by Beta Not compensated by market
- Examples Market crash, inflation CEO departure, product recall
- Types of Unsystematic Risk
- 1. Business Risk
Business risk is the risk associated with a company's operations, management, and competitive position.
- Sources of Business Risk Examples
- Management quality Poor decisions, executive turnover
- Competition New competitors, market share loss
- Product issues Recalls, obsolescence
- Labor issues Strikes, unionization
- Industry changes Technological disruption
- Operational problems Supply chain failures
Example : A pharmaceutical company's drug fails clinical trials—this affects only that company, not the entire market.
2. Financial Risk
Financial risk is the risk arising from a company's use of debt (leverage) in its capital structure.
- Leverage Level Financial Risk Implications
- Low debt Lower More financial flexibility
- High debt Higher Fixed interest payments required; bankruptcy risk
Key Point : Financial risk increases with leverage because:
- Interest must be paid regardless of profits
- Debt covenants restrict flexibility
- High debt increases bankruptcy probability
- Earnings become more volatile
- Measured by : Debt-to-equity ratio, interest coverage ratio
- 3. Credit Risk (Default Risk)
Credit risk is the risk that a borrower fails to make required payments on debt obligations.
- Rating Category Default Risk Example
- Investment Grade (BBB/Baa and above) Lower U.S. Treasury, Apple
- High Yield/Junk (BB/Ba and below) Higher Speculative companies
- Credit Rating Agencies : Moody's, S&P, Fitch
- S&P Rating Moody's Rating Classification
- AAA Aaa Highest quality
- AA Aa High quality
- A A Upper medium grade
- BBB Baa Medium grade (lowest investment grade)
- BB Ba Speculative
- B B Highly speculative
- CCC Caa Substantial risk
- D C In default
- 4. Liquidity Risk
Liquidity risk is the risk of not being able to sell an investment quickly at a fair price.
- Characteristics of Illiquid Investments Examples
- Wide bid-ask spreads Penny stocks
- Low trading volume Thinly traded bonds
- Long settlement periods Real estate
- Lock-up periods Private equity, hedge funds
- No active market Limited partnerships
Liquidity Spectrum :
- More Liquid Less Liquid
- Large-cap stocks Small-cap stocks
- Treasury securities Corporate bonds
- Money market funds Real estate
- Major ETFs Private equity
- 5. Legislative/Regulatory Risk
Legislative risk is the risk that laws or regulations will negatively affect a specific company or industry.
- Industry Regulatory Risk Example
- Healthcare Drug pricing legislation
- Financial services Banking regulations
- Energy Environmental regulations
- Technology Privacy laws, antitrust
- Tobacco Advertising restrictions
- 6. Concentration Risk
Concentration risk is the risk from lack of diversification—having too much exposure to a single investment.
Examples of Concentration Risk :
- Employee with 80% of portfolio in company stock
- Investor holding only technology stocks
- Retirement savings entirely in one mutual fund
- The Power of Diversification
Diversification is the primary tool for reducing unsystematic risk:
- Number of Stocks Unsystematic Risk Remaining
- 1 stock 100%
- 10 stocks ~50%
- 20 stocks ~25%
- 30+ stocks Minimal (~5-10%)
Research Finding : Approximately 20-30 uncorrelated stocks can eliminate most unsystematic risk. Beyond that, additional diversification provides diminishing benefits.
Types of Diversification
- Diversification Type Risk Reduced
- Within asset class Own stocks across multiple industries
- Across asset classes Stocks, bonds, real estate
- Geographic Domestic and international
- Time (dollar-cost averaging) Spread purchases over time
- In Practice: How Investment Advisers Apply This
Portfolio construction :
- Ensure adequate diversification (20+ securities minimum)
- Diversify across industries and sectors
- Consider correlation between holdings
- Watch for concentration in client-held assets (company stock)
Client education :
- Explain that diversification eliminates company-specific risk
- Help clients understand they shouldn't panic over single-company news
- Discuss the dangers of concentrated positions (employer stock)
- On the Exam
The Series 65 exam tests your understanding of:
- Definition of unsystematic risk and that it CAN be diversified away
- Types : Business, financial, credit, liquidity, legislative, concentration
- Relationship between diversification and unsystematic risk reduction
- How many stocks are needed to diversify (20-30)
- Credit ratings and what they measure
Common formats include identifying which risks are diversifiable and understanding credit risk.
- Key Takeaways
- Unsystematic risk affects specific companies and CAN be diversified away
- Business risk relates to company operations and management
- Financial risk increases with leverage (debt)
- Credit/default risk is the risk of non-payment on debt
- Liquidity risk is the difficulty of selling quickly at fair price
- 20-30 uncorrelated stocks eliminate most unsystematic risk
- Diversification reduces unsystematic risk but NOT systematic risk
- Credit ratings (S&P, Moody's) measure default risk