Diversification
Theory Characteristics
Investment
risk can be diversified by holding diversified investment portfolio i.e.
investment in different companies. it reduces the risk of extremely low or
extremely high return by balancing effect.
Some
investment provides extremely high return other would provide extremely low
return, this high & low return balance each other and at the end of day you
get a balanced return.
1. Diversification and positive
Correlation
Risk
is not reducing, if two investments are positively correlated. This is the
situation of companies from the same sector. For example if you have made all
investment in oil companies, then your risk is not diversified due to positive
correlation between these companies.
2. Diversification and Negative
Correlation
Risk
can be reduced by making investment in companies, whose return are negatively
correlated. it means on return increase, then other return fall. Famous example
is umbrella & ice cream Company.
3. Diversification with no correlation
Risk
can also be reduced by investment in companies; those have neither positive nor
negative correlation.
