CHAPTER 1 INTRODUCTION

1.1 MEANING OF RISK AND RETURN RELATIONSHIP

An investment is rarely free of risk. Even the risk- free securities that we usually
talk of in this subject, in the form of government securities, face an element of risk,
howsoever insignificant it may be. They are considered risk-free securities, because under
normal circumstances the government system does not fail and interest payments as well
as principal payments are absolutely assured. Securities become increasingly risky as we
shift from government securities to corporate debentures/bonds to equity shares. In other
words, risk and return are directly proportional. The higher the return, the more is the risk
and vice-versa, while other things remain same.
The relationship between risk and return is one of the essential concepts of
investment management, and is unique for every investor. People generally invest in an
asset keeping a targeted rate of return in mind. Risk is uncertainty that the expected return
on investment may not be realized. Risk tolerance is highly individual, based on a mix of
subject traits and objective circumstances. While some investors may be willing to
withstand a higher level of market volatility, others may prefer a more conservative
approach. Hence, understanding the risk profile of an investor and how it translates into a
disciplined approach to investing is crucial.
Risk originates in decision-making which relates to some future period. Decisions
are normally focused on some event, the future outcome of which may not be perfectly

predictable. This brings in the concept of risk. Risk is generally equated with the potential
of an investment to incur a financial loss. Return is the usual measure of performance. As
investment which offer higher potential for total return generally carry a higher potential
for risk, the informed investor do not simply seek to maximize returns. Instead, they
focus on risk with which they are comfortable. Rational decision-making requires the
availability of prior information about the future events. Accordingly, there may be
conditions of certainty and uncertainty; the former where there is complete information
about the future, and the latter where is none between the two extremes lays the risk zone.
Returns defined as the gain in the value of investment. The return on an
investment portfolio helps an investor to evaluate the financial performance of the
investment. For example, if the long term projections require that an investment should
achieve an 8% annual return, the assets may have to be reallocated if the return falls
below that, mark over a period of time. However, inflation reduces the buying power of
the investment return.
Inflation is a persistent increase in prices, triggered when demand for goods is
greater than the available supply or when the cost of production rises. Moderate inflation
typically accompanies economic growth, but the central banks try to keep inflation in
check, usually by decreasing the money supply when inflation heats up, making it more
difficult to borrow and slowing the expansion. Since inflation diminishes the buying
power of money, it is important that the rate of return on the overall investment grows
rather than shrinking in value over time diversify, and in turn invest in not just one but a
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group of assets in order to manage the risk. It is possible and is generally found that one
can arrive at a better combination of risk and return for the portfolio than what might be
there for the individual constituent assets. The overall risk is likely to be reduced by
being into more than one asset. Because of risk reduction, the nature of risk is
fundamentally different when an asset is viewed as part of a portfolio instead of being
viewed in isolation.
Generally, the higher the risk of an investment, the higher the potential return.
There is no guarantee that you will actually get a higher return by accepting more risk.
Higher risk only increases the potential for higher returns you could get a lower return
or even lose money.
Some investments are riskier than others theres a greater chance you could lose
some or all of your money. For example, Canada Savings Bonds (CSBs) have very low
risk because they are issued by the government of Canada. GICs and bank deposits also
carry low risk because they are backed by large financial institutions. With GICs and
deposits you also have the additional protection of deposit insurance on amounts up to
$100,000 if your financial institution goes bankrupt. With these low-risk investments you
are unlikely to lose money. However, they have a lower potential return than riskier
investments and they may not keep pace with inflation.
Over the long-term, bonds have a potentially higher return than CSBs and GICs,
but they also have more risks. Their prices may drop if the issuer's creditworthiness
declines or interest rates go up. If prices drop, you will incur a loss.
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Stocks have a potentially higher return than bonds over the long term, but they are
also riskier. Bond investors are creditors. As a bond investor, youre legally entitled to
fixed amounts of interest and principal and are repaid in priority if the company goes
bankrupt. However, if the company is successful, you wont earn more than the fixed
amounts of interest and principal. Shareholders are owners. As a shareholder, if the
company is unsuccessful, you could lose all of your money. But if the company is
successful, you could see higher dividends and a rising share price.
Some investments, such as those sold on the exempt market are highly speculative and
very risky. They should only be purchased by investors who can afford to lose all of the
money they have invested.

1.2 PORTFOLIO ANALYSIS AND PROCEDURE FOR MAKING

PORTFOLIO ANALYSIS
MEANING
Portfolio analysis is a systematic way to analyze the products and services that
make up an association's business portfolio. All associations (except the simplest and the
smallest) are involved in more than one business. Some of these include publishing,
meetings and conventions, education and training, government representation, research,
standards setting, public relations, etc. Each of these is one of the association's strategic
business units (SBUs). Each business consists of a portfolio of products and services.
For example, an association's publishing business might include a professional journal, a
lay magazine, specialized newsletters geared to different member segments, CDs, a
website, social networking sites, etc.
Portfolio analysis helps you decide which of these products and services should be
emphasized and which should be phased out, based on objective criteria. Portfolio
analysis consists of subjecting each of the association's products and services through a
progression of finer screens. During a time of cutbacks and scarce resources, it is
essential to screen out programs and services that are not essential to most members.
Those that appeal to a more limited segment can be funded by those desiring the product
or service rather than by dues.
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ADVANTAGES AND DISADVANTAGES OF PORTFOLIO ANALYSIS

Portfolio analysis offers the following advantages:
1. It encourages management to evaluate each of the organization's businesses
individually and to set objectives and allocate resources for each.
2. It stimulates the use of externally oriented data to supplement management's intuitive
judgment.
3. It raises the issue of cash flow availability for use in expansion and growth.
Portfolio analysis does, however, have some limitations.
1. It is not easy to define product/market segments.
2. It provides an illusion of scientific rigor when some subjective judgments are involved.
Considering both its advantages and disadvantages, portfolio analysis should be regarded
as a disciplined and organized way of thinking about asset allocation. It is only a
subjective tool, however, and is not a substitute for the ultimate professional judgment of
the responsible decision-makers.

PROCEDURE FOR MAKING PORTFOLIO ANALYSIS

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Step 1: Identify Lines of Business

The first step in portfolio analysis is to identify the lines of businesses (SBUs) that make
up the association's portfolio. The guideline to keep in mind is this: if we were a
corporation instead of a professional society, which groups of programs would be logical
candidates to be grouped together as independent businesses?
Step 2: Group Lines of Business
There are three lines of businesses an association typically engages in. The first is core
businesses that are of vital importance to your broad membership.

These are the

businesses that directly support the objectives in the strategic plan and have a priority
claim on resources.
The second line of business is support functions that make it possible to deliver the core
business benefits to members.

Examples of support functions are administrative,

accounting, legal, governance support, etc.

These do not have a priority claim on

resources. Rather, the objective is to minimize the cost of these functions and transfer
resources to support the core business.
The third line of business is money-makers that provide low-priority member benefits but
are the source of revenues that support the associations core businesses. Ideally, the
associations core businesses should be self-supporting and perhaps even contribute to
reserves. Often, this is not the case and activities must be subsidized with other income.

Money-makers provide this income. Examples of money-makers are rental car discounts,
affinity cards, insurance programs.
Step 3: Compare Core Businesses with Mission Statement
Once you have separated out your core businesses, compare them with the association's
mission statement. To pass this screen, a business must directly support the goals that are
defined in the mission statement. Support should be direct and not peripheral. If a line of
business does not support the strategic plan, it should be discontinued or phased out and
its resources transferred to support the association's other core businesses.
Step 4: Define Products and Services in Each Line of Business
Once lines of business have been tested for relevance to the mission statement, the next
step is to subdivide those that are relevant into their component products and services.
For example, the publishing business would be subdivided into each of its products.
Each product or service would then be compared to the Program Evaluation Matrix.
Step 5: Apply the Program Evaluation Matrix
The Program Evaluation Matrix is a graphic device that simplifies the process of
analyzing all the products and services in the association's portfolio of products and
services. In running its programs through the Program Evaluation Matrix, the association
makes several assumptions.
Assumptions

1. Since the need for resources is competitive, the association must view the problem of
securing resources in a competitive context.
2. It is preferable to provide good service to a focused market than to provide mediocre or
poor service to too large a market.
3. It is pragmatic to surrender mediocre programs to better competitors and wrest away
promising programs from weaker competitors.
Evaluating Program Characteristics
The Program Evaluation Matrix helps an association determine the answers to the
following questions about each product or service in its portfolio:
1. Is it a good fit with our other programs?
2. Is it easy to implement?
3. Is there poor alternative coverage in the marketplace?
4. Is our competitive position strong?
For a program to survive the competition for the association's resources, there should be a
positive response to all these questions. No program is in a strong position unless it is
superior to all programs in that category. If it is not, it should be classified as being in a
weak position.

The effect of these generic strategies is to serve the client base with a small number of
strong, excellent providers rather than with a larger number of fragmented providers
competing for limited dollars.
Step 6: Determine Product Fit
Using the Program Evaluation Matrix, the first step is to determine whether the product
or service under review fits the association's mission and priorities. The screens for good
product fit are:
1. Congruence with mission and purpose of the association.
2. Focus on core concerns that are of vital interest to the association's
members/customers.
Step 7: Determine Ease of Funding and Implementation (Is this an easy business?)
The criteria for determining whether a program or service has the prospect of relatively
easy funding and implementation are:
1. High appeal to groups capable of providing current and future support.
2. Stable source of funding.
3. Market demand from a large, concentrated, growing client base.
4. Appeals to volunteer leadership.
5. Measurable, reportable program results.

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Step 8: Determine Availability of Alternative Coverage

This is the first step in a competitive analysis. Even nonprofits operate in a competitive
environment, which has a strong impact on the ability to successfully deliver member
products and services.

Alternative coverage means is anyone else offering similar

programs. Programs should be classified according to two alternatives:

1. Low coverage: If there are few comparable programs offered elsewhere.
2. High coverage: If many similar programs are offered elsewhere.
Step 9: Assess Competitive Position of Product or Service
The following criteria should be considered in determining whether an association
product or service is in a strong competitive position. Competition is not limited to other
nonprofits. For-profit companies can and do compete directly with the association in the
delivery of many products and services.

Publications are a good example of this.

Criteria for a strong competitive position are:

1. Dominant market share or strong prospects for achieving market dominance.
2. Better quality/value/service than competitors.
3. Superior ability to produce and market this program.
4. Cost-effective program delivery.
5. Strong match between the program and the future needs of members/customers.
Step 10: Determine Program Fit
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Ideally, the association will have two types of programs:

1. Well-fitting, easy programs where the association has a strong position and competes
aggressively for a dominant position.
2. Well-fitting, difficult programs with low coverage that the association has the unique,
strong capability to provide to important stakeholders.
Applying these steps will reveal the association's current portfolio situation. The
ideal would be to have a portfolio that has primarily winners, and contains enough
winners and profit producers to finance the growth of potential winners. In reality,
however, there will probably be a few question marks and even perhaps a small loser.
Then, of course, there are those untouchable programs that, although marginal or even
losers, are considered to be of fundamental importance to members and must be
subsidized.
Summing Up
Portfolio analysis is an important aid in the association's quest to identify its
specific competitive role. This role should be so well suited to the association's external
and internal environments that other associations are unlikely to challenge or dislodge it.
The association then has a distinctive competence that enables it to take advantage of
specific environmental opportunities. To accomplish this, the association must be on the
constant lookout for strategic windows or market opportunities.

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In todays competitive world, successful associations will have three characteristics in

common, and portfolio analysis will have an important role to play in helping
associations achieve them.
They will innovate as a way of life.
They will compete on value in meeting member needs, not on price.
They will achieve leadership in related niche markets.

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CHAPTER 2 RESEARCH METHODOLOGY

Research Methodology includes two sources of data:

SECONDARY DATA:
Internet-Websites.
Reference Books.

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CHAPTER 3 UNDERSTANDING OF CONCEPT

3.1 MEANING OF PORTFOLIO
A collection of investments all owned by the same individual or organization.
These investments often include stocks, which are investments in individual businesses;
bonds, which are investments in debt that are designed to earn interest; and mutual funds,
which are essentially pools of money from many investors that are invested by
professionals or according to indices. The term portfolio refers to any collection of
financial assets such as cash. Portfolios may be held by individual investors and/or
managed by financial professionals, hedge funds, banks and other financial institutions. It
is a generally accepted principle that a portfolio is designed according to the investor's
risk tolerance, time frame and investment objectives. The monetary value of each asset
may influence the risk/reward ratio of the portfolio and is referred to as the asset
allocation of the portfolio. When determining a proper asset allocation one aims at
maximizing the expected return and minimizing the risk. This is an example of a multiobjective optimization problem: more "efficient solutions" are available and the preferred
solution must be selected by considering a tradeoff between risk and return. In particular,
a portfolio A is dominated by another portfolio A' if A' has a greater expected gain and a
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lesser risk than A. If no portfolio dominates A, A is a Pareto-optimal portfolio. The set of

Pareto-optimal returns and risks is called the Pareto Efficient Frontier for the Markowitz
Portfolio selection problem.
There are many types of portfolios including the market portfolio and the zeroinvestment portfolio. A portfolio's asset allocation may be managed utilizing any of the
following investment approaches and principles: equal weighting, capitalizationweighting, price-weighting, risk parity, the capital asset pricing model, arbitrage pricing
theory, the Jensen Index, the Treynor the Sharpe diagonal (or index) model, the value at
risk model, modern portfolio theory and others.
There are several methods for calculating portfolio returns and performance. One
traditional method is using quarterly or monthly money-weighted returns, however the
true time-weighted method is a method preferred by many investors in financial markets.
There are also several models for measuring the performance attribution of a portfolio's
returns when compared to an index or benchmark, partly viewed as investment strategy.

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3.2 EXPECTED RETURN OF A PORTFOLIO

For the most part, the expected return is a tool used to determine whether or not an
investment has a positive or negative average net outcome - it is not a hard and fast figure
of profit or loss.
In addition to expected return, wise investors should also consider the probability
of return in order to properly assess risk. After all, one can find instances in which certain
lotteries offer a positive expected return, despite the very low probability of realizing that
return.
Expected return is calculated as the weighted average of the likely profits of the
assets in the portfolio, weighted by the likely profits of each asset class. Expected return
is calculated by using the following formula:
E(R) = w1R1 + w2Rq + ...+ wnRn
Example: Expected Return

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For a simple portfolio of two mutual funds, one investing in stocks and the other in
bonds, if we expect the stock fund to return 10% and the bond fund to return 6% and our
allocation is 50% to each asset class, we have the following:
Expected return (portfolio) = (0.1)*(0.5) + (0.06)*(0.5) = 0.08, or 8%
Expected return is by no means a guaranteed rate of return. However, it can be used to
forecast the future value of a portfolio, and it also provides a guide from which to
measure actual returns.
Let's look at another example. Assume an investment manager has created a
portfolio with Stock A and Stock B. Stock A has an expected return of 20% and a weight
of 30% in the portfolio. Stock B has an expected return of 15% and a weight of 70%.
What is the expected return of the portfolio?
E(R) = (0.30)(0.20) + (0.70)(0.15)
= 6% + 10.5% = 16.5%
The expected return of the portfolio is 16.5%.

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3.3 RISK OF PORTFOLIO

Chance that combination of assets or units within individual group of investments
fail to meet financial objectives. In theory, portfolio risk can be eliminated by successful
diversification.
An investor can reduce portfolio risk by holding combinations of instruments
which are not perfectly positively correlated (correlation coefficient). In other words,
investors can reduce their exposure to individual asset risk by holding a diversified
portfolio of assets. Diversification may allow for the same portfolio expected return with
reduced risk.
Three assets (apples, bananas, and cherries) can be thought of as a bowl of fruit.
The index is a fruit basket. A full fruit basket probably has 10 or 15 different fruits, but
my bowl will be efficient as much as its statistical parameters (risk and return) mimic
those of the whole basket. In this unit, we are talking about calculating the risk of a
portfolio. In addition, we can extend the implications made by the security market line
theory from individual assets to portfolios.

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The Capital Asset Pricing Model tells us there are two forms of risk to which all
portfolios are exposed:
Systematic Risk:
Also known as beta and market risk, this is a macro-level threat.

For example, a

recession could depress the performance of the entire stock market. Systematic risk is
evident when a diverse set of stocks, such as the S&P 500 Index, experience a decline.
Hedging is the only means of mitigating this problem.
Individual Stock Risk:
Also known as specific, idiosyncratic, and diversifiable risk, this is security-specific. For
example, a company could make a poor business decision that leads to a lowering of their
stock price. In this scenario, the stock market may continue to rise, but this particular
stock's price would fall. Holding a diversified portfolio of stocks can mitigate this type of
risk.

Calculating Portfolio Risk

To calculate the risk in my bowl, we need a little more background information on
fruit markets. First, we are going to need the variance for each fruit. Remember that the
standard deviation answers the question of how far do I expect one individual outcome to
deviate from the overall mean. And variance is that number squared. Mathematically, the
formula is:
$V(R)={ [R-E(R)] }^{ 2 }$
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It is the expected value of the difference between the individual return in a given day (R)
and the average outcome average return over a year (E(R)).

3.4 REDUCTION OF PORTFOLIO RISK THROUGH

DIVERSIFICATION
Diversification, in its most elementary form, means being into more than one
things. A portfolio normally faces both the systematic as well as unsystematic risk. The
systematic risks are caused by macro factors such as political upheaval, an oil crisis or an
unexpected change in the rate of inflation. Such factors affect nearly all companies to one
degree or the other. Thus it is not possible to reduce systematic risk. By diversifying
investment across the assets of different companies.
On the other hand, the source of unsystematic risks are micro factors which have
an impact on individual companies/sectors but have no sweeping impact on the general
level of the securities market, i.e. on all the companies as a whole. These factors include
strikes, promoter family split or death of a key manager. Since factors like these affect
only individual companies so their negative impact can be reduced by holding securities
of more than one unrelated company. Thus unsystematic risk can be managed by
diversifying the portfolio while the systematic risk cannot be. They are, therefore, also
known as diversifiable and non- diversifiable risks, respectively. Depending on the

21

market, a portfolio of some well selected assets might be sufficiently diversified to leave
the portfolio exposed to systematic risk only.
Efforts to spread and minimize the portfolio risk take the form of diversification.
Diversification helps an investor to reduce the overall risk of investment also called as the
portfolio risk while not reducing the expected returns. It does so by simply reducing the
concentration of investments into more than one assets and that too those having a
correlation coefficient for their returns of less than one. For diversification to work, the
component assets must not be perfectly correlated, i.e. covariance must not be equal to 1.
Diversification leads to an averaging of systematic risk as it can substantially
reduce the unsystematic risk. As a portfolio becomes more diversified, its unique risk
becomes smaller, and hence the total risk.
Diversification can be of two types, viz. random and efficient. Random
diversification is a process of adding randomly selected assets to the portfolio and
combining them in equal proportions to reduce the portfolios systematic risk. It
implicitly assumes that an investor has no knowledge of the standard deviations and
correlations of the on assets. This situation contrasts with the modern portfolio theory. An
investor can make maximum use of diversification by using the values of the expected
risk of assets, as is reflected in the efficient set, by explicitly considering their standard
deviations and correlations. Such a diversification is known as efficient diversification.
Diversification is a way to try to reduce the risk of your portfolio by choosing a
mix of investments.
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Working Of Diversification
Under normal market conditions, diversification is an effective way to reduce risk. If you
hold just 1 investment and it performs badly, you could lose all of your money. If you
hold a diversified portfolio with a variety of different investments, its much less likely
that all of your investments will perform badly at the same time. The profits you earn on
the investments that perform well offset the losses on those that perform poorly.
For example, bonds and stocks often move in opposite directions. When investors expect
the economy to weaken and corporate profits to drop, stock prices will likely fall. When
this happens, central banks may cut interest rates to reduce borrowing costs and stimulate
spending. This causes bond prices to rise. If your portfolio includes both stocks and
bonds, the increase in the value of bonds may help offset the decrease in the value of
stocks. The reason for including bonds in a portfolio is not to increase returns but to
reduce risk.
In theory, diversification enables you to reduce the risk of your portfolio without
sacrificing potential returns. An efficient portfolio has the least possible risk for a given
return. Once your portfolio has been fully diversified, you have to take on additional risk
to earn a higher potential return on your portfolio. This chart shows the impact of
diversification on a portfolio, and how risk changes when you seek higher potential
returns.
Each specific investment has specific risks. For example, if you invest in a car
company that buys unique parts from a manufacturer in the Eurozone and the price of the
23

Euro goes up in relation to the Canadian dollar, the companys costs will rise and profits
will fall. In this case, share prices may drop too. Other specific investments wont be
subject to the same risk at the same time. You reduce your overall risk by diversifying
your portfolio. Similarly, you can diversify the bond portion of your portfolio by
including a mix of bonds with different credit ratings and durations. This is effective
because the values of bonds with strong credit ratings and those of bonds with weak
credit ratings respond differently to changes in the economy. Similarly, bond values
respond differently to changes in interest rates depending on their duration.
You evaluate the risk of a portfolio by looking at its volatility. When evaluating the
risk of an individual investment, its own volatility does not matter. Instead, consider what
the investment will do to the volatility of your portfolio. The portfolio's volatility will be
reduced if the investment's returns do not move exactly in line with those of the portfolio.

Diversification versus Hedging

Portfolio risk can be lowered by utilizing two related, but different, techniques.
Systematic risk can be reduced through hedging, while individual stock risk can be
reduced through diversification. The difference between the two concepts is subtle, but
worthwhile reviewing:
Diversification:

24

Generally, as the number of assets in a portfolio increases, the risk of the portfolio
decreases. Diversification relies on a loose relationship between the returns of the assets
in the portfolio. For example, among a group of ten stocks, one company might make a
poor business decision, which results in a decrease in that stock's price. However, the
return on investment for the remaining nine companies were unaffected by this decision.
Hedging:
When two assets are negatively correlated, they can be held together in a portfolio
to reduce systematic risk. For example, during an economic recession, the prices of
stocks will be depressed. Fortunately, the price of gold typically rises during a recession.
This negative correlation means that gold can be held as a hedge against inflation.
To summarize, the concept of diversification applies to similar assets with
uncorrelated returns. The concept of hedging applies to dissimilar assets with returns that
are negatively correlated.
Risk and Diversification: Diversifying Your Portfolio
With the stock markets bouncing up and down 5% every week, individual
investors clearly need a safety net. Diversification can work this way and can prevent
your entire portfolio from losing value.
Diversifying your portfolio may not be the sexiest of investment topics. Still, most
investment professionals agree that while it does not guarantee against a loss,
diversification is the most important component to helping you reach your long-range
25

financial goals while minimizing your risk. Keep in mind, however that no matter how
much diversification you do, it can never reduce risk down to zero.
What do you need to have a well diversified portfolio? There are three main things
you should do to ensure that you are adequately diversified:

1.Your portfolio should be spread among many different investment vehicles such
as cash, stocks, bonds, mutual funds, and perhaps even some real estate.
2.Your securities should vary in risk. You're not restricted to picking only blue
chip stocks. In fact, the opposite is true. Picking different investments with different rates
of return will ensure that large gains offset losses in other areas. Keep in mind that this
doesn't mean that you need to jump into high-risk investments such as penny stocks!
3.Your securities should vary by industry, minimizing unsystematic risk to small
groups of companies.
Another question people always ask is how many stocks they should buy to reduce
the risk of their portfolio. The portfolio theory tells us that after 10-12 diversified stocks,
you are very close to optimal diversification. This doesn't mean buying 12 internet or tech
stocks will give you optimal diversification. Instead, you need to buy stocks of different
sizes and from various industries.
Risk and Diversification: Conclusion
26

Different individuals will have different tolerances for risk. Tolerance is not static,
it will change as your life does. As you grow older tolerance will usually shrink as more
and more obligations come up, including retirement.
There are several different types of risks involved in financial transactions. I hope
we've helped shed some light on these risks. Achieving the right balance between risk and
return will ensure that you achieve your financial goals while allowing you to get a good
night's rest.
Reasons to Diversify
Let's say you have a portfolio of only airline stocks. If it is publicly announced that
airline pilots are going on an indefinite strike, and that all flights are canceled, share
prices of airline stocks will drop. Your portfolio will experience a noticeable drop in
value. If, however, you counterbalanced the airline industry stocks with a couple of
railway stocks, only part of your portfolio would be affected. In fact, there is a good
chance that the railway stock prices would climb, as passengers turn to trains as an
alternative form of transportation.
But, you could diversify even further because there are many risks that affect both
rail and air, because each is involved in transportation. An event that reduces any form of
travel hurts both types of companies - statisticians would say that rail and air stocks have
a strong correlation. Therefore, to achieve superior diversification, you would want to
diversify across the board, not only different types of companies but also different types
of industries. The more uncorrelated your stocks are, the better.
27

It's also important that you diversify among different asset classes. Different assets
- such as bonds and stocks - will not react in the same way to adverse events. A
combination of asset classes will reduce your portfolio's sensitivity to market swings.
Generally, the bond and equity markets move in opposite directions, so, if your portfolio
is diversified across both areas, unpleasant movements in one will be offset by positive
results in another.

There are additional types of diversification, and many synthetic investment

products have been created to accommodate investors' risk tolerance levels; however,
these products can be very complicated and are not meant to be created by beginner or
small investors. For those who have less investment experience, and do not have the
financial backing to enter into hedging activities, bonds are the most popular way to
diversify against the stock market.
Unfortunately, even the best analysis of a company and its financial statements
cannot guarantee that it won't be a losing investment. Diversification won't prevent a loss,
but it can reduce the impact of fraud and bad information on your portfolio.
How Many Stocks You Should Have
Obviously owning five stocks is better than owning one, but there comes a point
when adding more stocks to your portfolio ceases to make a difference. There is a debate
over how many stocks are needed to reduce risk while maintaining a high return. The

28

most conventional view argues that an investor can achieve optimal diversification with
only 15 to 20 stocks spread across various industries. (To learn more about what
constitutes a properly diversified stock portfolio, see Over-Diversification Yields
Diminishing Returns. To learn about how to determine what kind of asset mix is
appropriate for your risk tolerance, see Achieving Optimal Asset Allocation.)

CHAPTER 4 SUMMARY OF THE STUDY

4.1 CONCLUSION
Diversification can help an investor manage risk and reduce the volatility of an
asset's price movements. Remember though, that no matter how diversified your portfolio
is, risk can never be eliminated completely. You can reduce risk associated with
individual stocks, but general market risks affect nearly every stock, so it is important to
diversify also among different asset classes. The key is to find a medium between risk
and return; this ensures that you achieve your financial goals while still getting a good
night's rest.

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CHAPTER 5 APPENDICES

5.1 REFERENCES

REFERENCE BOOKS
Avadhani, V.A., Investment Management, Himalaya Publication House, 2013, pp.

17-18, 22, 224-225.

Kevin. S., Portfolio Management, PHI Publication.

WEBSITES
http://www.investopedia.com/articles/02/111502.asp
https://www.boundless.com/finance/textbooks/boundless-financetextbook/introduction-to-risk-and-return-8/implications-across-portfolios80/portfolio-risk-350-3893/
http://www.zenwealth.com/businessfinanceonline/RR/Portfolios.html
http://www.fundacionsepi.es/revistas/paperArchive/Ene2009/v33i1a3.pdf

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