International Financial Markets - Assignment Example

Whereas in hedging, it banks on negative linkage between assets or shorting assets that possess a positive correlation. The modest illustration of diversification is driven home by the proverb that says you should not put all your eggs in a single basket. Moreover, the placement of each egg separately in dissimilar baskets is considered to be more diversified. The risk of losing one egg is more than losing all of them. Therefore diversification aims to downplay the risks through allocating investments between different industries, financial instruments, and other categorizations.

Its aims are to maximize the returns by capitalizing in diverse fields that would each respond in a different manner to the same result. Although diversification does not assure one to be free from losses, it is the most important factor that will enable an individual to achieve long-range goals financially and at the same time downplaying the dangers (Denis et al. 2002). When investing, one has to be mindful of the dangers that come along with the deed. There are two primary classes of risks that an investor confronts with while investing.

They include unverifiable and diversifiable. Firstly, unverifiable, also known as the market or systematic risk is linked to every society. This case of risks is caused by things like exchange rates, war, inflation rates, interest rates and political instability. Furthermore unverifiable is not believed to be exact to a particular industry or company, and this character of risk cannot be trimmed down or be eliminated by diversification. Hence, it is a danger that investors should come into term with and learn to exist with it.

Secondly, diversifiable also referred to as unsystematic risk. This risk is specific to a certain market, state, economy, industry, and market. Unlike unverifiable, this danger can be mitigated by diversification. Moreover, the main