Theoretical Concepts Underpinning Portfolio Diversification Assignment

Theoretical Concepts Underpinning Portfolio Diversification - Assignment Example 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 are 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). ... The diversification speed of the value at risk is regarded as the rate at which the value at risk changes because the number of assets included in the portfolio increases. (Ansoff n.d. p. 113). 3The criteria of value at risk are evaluated at a probability level that is fixed. One can also launch the converse analysis where the level of the value at risk is kept fixed and the level of the probability changes with an increase in the number of assets. A majority of the theoretical literature in finance assumes that returns are distributed normally. The speed of diversification is different in cases of normal and other distributions. The diversification speed is higher for the finite variance classes relative to the speed of normal distribution. The speed is lower relative to the speed of the diversification of the risk level (Hyung and Vries, 2004, p. 3). 4 Suppose there are two stocks one with return 0f 8% and another with 15%. The expected range of return of the investor is 8% to 15%. The standard deviation of the former stock is .05 while that of the later is 2. The investor will quantify the associated risk of the two assets and diversifies the investments accordingly. Country wise diversification can also arrive in the scenario (Marineilli, 2011, p. 2). 5 Measurement of the benefits of Diversification Suppose A and B are two portfolios. The former portfolio has an expected return and returns volatility of 7.5% with the qual weighing of both types of assets. But the later portfolio is leveraged in such a way that the weighing of the risk-free asset is -50% while that of the risky asset is 150%.