Which type of risk involves unexpected changes in interest rates affecting all firms?

The correct choice is systematic risk, as it refers to the inherent risk that affects the entire market or a significant segment of it, primarily due to factors such as changes in interest rates, economic cycles, inflation, and geopolitical events. When interest rates fluctuate unexpectedly, all firms are generally impacted since these changes can affect borrowing costs, consumer spending, and overall economic activity, making such risks systematic.

Systematic risk is also synonymous with market risk, although in this context, systematic risk distinguishes the broader market effects of interest rate changes from the specific risks associated with individual firms or industries. This is why it is important for investors to consider systematic risk when evaluating their portfolios, as it cannot be eliminated through diversification, unlike unsystematic risk, which is unique to a specific company or industry. Recognizing that systematic risk encompasses these broad economic factors helps in understanding the potential volatility in investment returns and the necessity for strategic risk management.