Question

2. Why does the required return on a stock only depend on its amount of systematic risk but not on its idiosyncratic risk?

Answer 1

2. The required return on stock only depends on the systematic risk affecting the stock because, this risk uniformly affects all securities and this risk cannot be diversified so investors need to be compensated for the exposure to this risk. The higher the systematic risk, the higher would be the required return demanded by the investors.

Unsystematic risk, is the risk that can be easily diversified. This risk is unique to a particular stock and can be reduced or eliminated by diversification. For example, lockout in a company affects the operations of that particular company and not the whole economy. So, this risk cannot be compensated.