Research Korner: Capital Asset Pricing Model

Diversification Reduces Risk

THE IMPORTANCE OF DIVERSIFICATION         In a company diversification is very important especially in risk reduction management system’ for instance; financial integration and or financing capital, capital allocation and many other marketing practice. Diversification aims to maximize potential investment or a quick return of investment for newly established businesses. It also aims to minimize risk in order to accomplish goals and market adaptability depending on company’s situational position. If a certain company would not adapt such diversification process possibility of closure is at hand. A company whose financial position of capital allocation is stagnant may also have the same position of shut down because of lack of resources of financial outcome. The Capital Asset Pricing Model has introduced this kind of risk reducing scheme to revolutionize the theory of investing which focuses on the option of investment.       What if a person or business do not assume diversification or do not have the capacity to diversify; let us see an example - A certain doctor who earned thousands of dollars in his profession invested all his money in one distribution multi-level and networking company who happened to be a leader in food and herbal production. Because of his confidence in the business he continuously gains expectation that his investment will continue to grow and so it does. But one time the government has put restriction on the business for non compliance in material acquisition, to make the story short this business left the country to migrate and the doctor has not been able to get his dividend on the business. This experience taught him a lesson to diversify his investment to reduce the risk of same awkward position.             There are many reasons why diversification should be practice even to a small and medium established businesses, to demonstrate a situation of diversification in an actual scenery in business let us introduce some companies who uses this technique;       If you are going to put your investment in a well known bank let’s say Metro Bank you are guaranteed that you eliminate the risk of 100% since Metro bank is a stable company and even if the bank declared an unexpected bankruptcy the government insurance policy will still assure your investment but then again the interest rate would be more or less than 5% of your investment. So to diversify you can divide your investment to a bank plus other businesses that offers a higher interest rate such as stocks, bonds, or partnership of existing business leaders although risk maybe higher but can be favorable like the example below;         Nestle the world leader in food distribution have partners of stock brokerage from around the world in most countries. In the Philippines they penetrate the market by merging to San Miguel Corporation their stocks for more than fifty years. During the early years of 2000 both companies decided to end their partnership. San Miguel sold their stocks to Nestle and thereby both companies experienced a win situation since Nestle have gain solidarity in management as well as market acceptability while San Miguel Corporation have additional capital stocks for their business. Such diversification has created both parties to gain more strength and stability. They have presumed an assumption of convergence before parting ways so as to reduce and basically eliminate the risk involve during their partnership.       BMW in Japan that produces luxurious automobiles was heavily affected by the recent Earthquake, the production flow was hampered and the danger is still there. If they have not promoted a diversified tactic the BMW business may result in company shut down. The diversified technique they use is to still produce parts of automobile and import these to other countries. Some automobile are sold at auction or a lower price. They may have not gain stable sales during these times of crisis but they have eliminated the risk of total insolvency.       Remember though that no matter how diversified your portfolio is, risk cannot be thoroughly eliminated. Risk will always be there depending on the circumstance but to be able to assume clearly and define your goal clearly in diversification you are guaranteed you have already performed your duty. In layman’s term the simplest example of diversification is provided by the proverb "don't put all your eggs in one basket". Dropping the basket will break all the eggs. Placing each egg in a different basket is more diversified. There is more risk of losing one egg, but less risk of losing all of them.

Diversification Reduces Risk

THE IMPORTANCE OF DIVERSIFICATION In a company diversification is very important especially in risk reduction management system’...