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Finance & Accounting
Pages 4 (1004 words)
Finance principles Contents Risk 3 Diversification 3 Theoretical concepts underpinning portfolio diversification 4 Measurement of the benefits of Diversification 5 Limitations 6 Risk The potential that a particular activity or a certain type of action will lead to an outcome that is undesirable is called risk…
Diversification A technique of risk management that takes into account a broad selection of investments within a portfolio is called diversification. (Lakshmanan and Amer-Yahia, n.d.). 1The rationale that guides this technique argues that a portfolio consisting of different kinds of investment on an average will give higher returns as well as pose a lower risk compared to any other individual investment that is found within the portfolio. As a result the positive performance of some investments will rule out the not so positive or negative performance of the other investments. The benefits from the process of diversification can only be accrued if the securities within the portfolio are perfectly uncorrelated. The first form of diversification takes place when the company has the potential to develop beyond the existing product market. The related form of diversification can be further categorized into backward diversification, forward diversification and horizontal diversification. Unrelated diversification takes place when an organization has the potential to develop interests that is complementary to its existing activities. When a company involved in media services can think of diversification in financial services, such kind of diversification is called unrelated diversification (Chatterjee and Wernerfelt, 1991). ...
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