Final answer:
The rate of return on a broad market index is a true representation of the common systematic factor that affects all stock returns, since it aggregates the performance of a range of stocks, capturing the market's overall systematic risk.
Step-by-step explanation:
The statement that the rate of return on a broad market index can reasonably proxy for the common factor affecting the rate of return on all stocks is true. A broad market index reflects the performance of a range of companies, essentially capturing the systematic risk affecting the market as a whole.
Index funds, for instance, are designed to imitate the overall behavior of the stock market. They provide a diversified exposure to a variety of stocks and thus are affected by systematic factors that influence the market, such as economic changes, political events, or shifts in investor sentiment. These systematic factors are indistinguishable for individual stocks but collectively impact the entire market.
Hence, the rate of return on a market index is considered a good measure of the overall market's systematic risk. Diversification, as practiced through mutual funds or index funds, helps to mitigate idiosyncratic risk - the risk specific to an individual stock.