Diversification cannot eliminate risk that is inherent in the macro-economy; this risk is called systematic or market risk. General financial market trends affect most companies in similar ways. Macroeconomic events, such as changes in GDP, rising optimism or pessimism among investors, tax increases or cuts, or a stronger or weaker dollar have broad effects on product and financial markets. Even a well-diversified portfolio cannot escape these effects. The only risk that should matter to financial markets is an asset’s systematic, or market risk that is, the sensitivity of the asset’s returns to macroeconomic events. The unsystematic, microeconomic component of an asset’s total risk disappears in a well-diversified portfolio. When financial markets evaluate the tradeoff between risk and expected return, they really focus on the tradeoff between systematic risk and expected return. Systematic risk (or market risk) is the risk that is inherent in the system. As such, it cannot be diversified away. The only way to escape systematic risk is to invest in a risk-free security. A risk-free asset, by definition, will have no systematic risk. In sum, only the systematic portion of risk matters in large, well-diversified portfolios. Thus, the expected returns must be related only to systematic risk. T