Why are some risks diversifiable and some non-diversifiable? Give an example of each.

A reasonable answer would, at a minimum, explain that some risks (diversifiable) affect only a specific security, and when put into a portfolio, losses as a result of these firm-specific events will tend to be offset by price gains amongst other securities. Nondiversifiable risk, however, is unavoidable because such risks affect all or almost all securities in the market and can't be eliminated by forming portfolios. In the second part of the question, the students get a chance to use a minor amount of imagination. A strong answer would note the dependence of diversification effects on the degree of correlation between the assets used to form portfolios.