NISM-Series-X-A: Investment Adviser (Level 1) · Introduction to Investment

Types of Investment Risks: Systematic and Unsystematic

Updated 11 October 2026 · Fact-checked

Investment risk is the chance that actual returns differ from expected returns. Systematic risks (market, interest rate, inflation) affect the whole market and cannot be diversified away. Unsystematic risks (credit, concentration, business-specific) affect one issuer or sector and can be reduced by diversification. Classify the risk first, then pick the answer.

Understand Types of Investment Risks

Every investment carries risk. Risk means the actual return may turn out different from what you expected, usually lower. Risk is not only the chance of losing money. It also covers earning less than planned.

Risks are split into two groups. Systematic risk comes from factors that hit the whole market or economy, such as a recession, a change in interest rates or rising prices. You cannot remove it by holding many securities. It is also called market risk in the broad sense or non-diversifiable risk.

Unsystematic risk is specific to a company, industry or issuer. Examples are a firm losing a big client, a management fraud or a bond issuer defaulting. Holding many different securities reduces it. It is also called diversifiable or specific risk.

The common types you must know:
- Market risk: prices fall because the overall market falls. Systematic.
- Interest rate risk: bond prices fall when market interest rates rise, and rise when rates fall. Systematic.
- Inflation (purchasing power) risk: rising prices reduce the real value of returns. Fixed deposits and bonds with fixed income suffer most. Systematic.
- Credit (default) risk: the issuer fails to pay interest or principal on time. Usually treated as unsystematic, since it relates to the issuer.
- Reinvestment risk: you must reinvest coupons or maturity proceeds at a lower rate than the original. Hurts when rates fall.
- Concentration risk: too much money in one security, sector or issuer. Unsystematic, cured by diversification.

Note that interest rate risk and reinvestment risk pull in opposite directions. Rising rates hurt bond prices but help reinvestment. Falling rates raise bond prices but hurt reinvestment.

Key formulas to remember

Total risk: Total risk = Systematic risk + Unsystematic risk; Diversification reduces only the unsystematic part.
Interest rate and bond price: Market interest rate ↑ → bond price ↓; market interest rate ↓ → bond price ↑; Inverse relationship. Applies to existing fixed-coupon bonds.
Real return (approximate): Real return ≈ Nominal return − Inflation rate; Shows the inflation risk effect. The exact form is (1 + nominal) ÷ (1 + inflation) − 1.
Reinvestment risk direction: Rates fall → reinvestment risk hurts; rates rise → reinvestment benefits; Opposite to the price effect on bonds.

How to solve Types of Investment Risks questions

Use this method for any question that asks you to name, classify or compare investment risks.

1Read the scenario and find the trigger: market fall, rate change, price rise, issuer default, reinvestment, or heavy exposure to one holding.
2Ask: does it affect the whole market or only one issuer, sector or holding?
3If it affects the whole market, label it systematic. If it is specific, label it unsystematic.
4Match the trigger to the named risk: rate change on bond price is interest rate risk; lower rate on coupon reinvestment is reinvestment risk.
5Check the direction: rising rates hurt bond prices; falling rates hurt reinvestment.
6Check whether diversification helps. If yes, it is unsystematic.
7Eliminate options that mix up two similar risks, then choose the one that fits the trigger exactly.

Quickest way: Trigger-word matching

When to use it: Use when you have under a minute per question and the options are risk names.

Spot the keyword: 'default' means credit; 'purchasing power' means inflation; 'coupon reinvested' means reinvestment; 'one stock or sector' means concentration; 'bond price falls as yield rises' means interest rate.
Decide systematic or unsystematic using one test: can diversification remove it?
Pick the option that matches both keyword and type.

Common mistakes in Types of Investment Risks

Saying diversification removes all risk.
Students remember that diversification helps and overextend it.
Fix: Diversification removes only unsystematic risk. Systematic risk stays.
Confusing interest rate risk with reinvestment risk.
Both involve interest rate changes.
Fix: Interest rate risk is about price change of the bond. Reinvestment risk is about the rate earned on reinvested cash flows. Rising rates hurt the first; falling rates hurt the second.
Calling inflation risk unsystematic.
Students link it to a single investment such as an FD.
Fix: Inflation affects the whole economy, so it is systematic.
Treating credit risk as a market-wide risk.
Defaults feel like big events.
Fix: Credit risk relates to a particular issuer, so it is treated as unsystematic, and diversification across issuers reduces it.
Thinking risk means only the chance of loss.
Everyday use of the word.
Fix: In investing, risk is variability of actual versus expected return, including earning less than expected.

Worked examples

Example 1

An investor holds a 9% coupon bond. Market interest rates then rise to 10%. Which risk has materialised, and what happens to the price of the bond?

Show the solution

The trigger is a change in market interest rates affecting an existing fixed-coupon bond.
This is interest rate risk, which affects the whole market, so it is systematic.
New bonds pay 10%, so the 9% bond becomes less attractive.
Its price must fall so that its yield rises towards the market rate.

Answer: Interest rate risk, a systematic risk; the bond price falls.

Example 2

An investor receives a 8% coupon each year from a bond. Market rates fall to 6%. The investor reinvests the coupon of ₹8,000 at 6%. What is the risk, and how much interest does the reinvested ₹8,000 earn in a year compared with 8%?

Show the solution

The coupon is being reinvested at a lower rate than the original 8%, so this is reinvestment risk.
Interest at 8% on ₹8,000 = ₹8,000 × 0.08 = ₹640.
Interest at 6% on ₹8,000 = ₹8,000 × 0.06 = ₹480.
Shortfall = ₹640 − ₹480 = ₹160 for the year.

Answer: Reinvestment risk; the investor earns ₹480 instead of ₹640, a loss of ₹160 a year.

Exam tips

Always sort the risk into systematic or unsystematic first. Many MCQs test only this split.
Remember the opposite effects: rising rates hurt bond prices, falling rates hurt reinvestment.
Watch for 'which risk can be reduced by diversification'. The answer is concentration or credit, not market or inflation.
In caselets, underline the trigger word before reading the options. Wrong answers carry a 25% negative mark, so do not guess blindly.

Practice questions from Introduction to Investment

Types of Investment Risks in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CMA IntermediateTypes of Risk: Systematic and Unsystematic

Types of Investment Risks: frequently asked questions

What is the difference between systematic and unsystematic risk?

Systematic risk affects the whole market or economy and cannot be diversified away. Unsystematic risk is specific to a company, sector or issuer and can be reduced by holding a diversified portfolio.

What is reinvestment risk with an example?

It is the risk of reinvesting coupons or maturity money at a lower rate. If you earn 8% on a bond and rates fall to 6%, the coupons you receive can only be reinvested at 6%.

Is credit risk systematic or unsystematic?

It is generally treated as unsystematic because it depends on the particular issuer. You can reduce it by spreading money across many issuers.

Which risk do fixed deposits face most?

Mainly inflation risk, because a fixed interest rate may not keep pace with rising prices. They also face reinvestment risk when rates fall at renewal.