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Advantages of a Diversified Portfolio

A portfolio is a collection of investments. A portfolio may refer to a collection of stocks in various industries or a combination of assets that includes real estate, bonds, annuities and blue chip stocks. A diversified portfolio is a good way of meeting one's financial goals while minimizing risk.

1. Diversification
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The term diversification means varied. Ideally an investment portfolio should contain a mixture of investment vehicles that will enable the investor to meet his financial goals within the desired time frame.

Types of Investments
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An investor may invest in real estate by buying and selling houses. She may also buy houses and rent them out to tenants. An investor may buy precious metals such as gold or silver. An investor may also invest in bonds or choose to invest in the stock market or stock markets in various countries. Sponsored Links Top 5 Mutual Funds Most Powerful SIP Services in India Open a Free A/C Now & Win iPad 3! FundsIndia.com/Top-5-Mutual-Funds

Risks
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One of the problems with any investment is the potential to lose money. If the price of a house you have purchased goes down and you need to sell, you may lose money on the deal. If a company goes bankrupt and you bought their stock, your company stock shares may be worthless.

Reducing Risk
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A well diversified portfolio can help reduce these risks. For many investors a well diversified portfolio means investing in various industries and various kinds of stock. An investor may invest in the technology sector as well as medical and publishing stocks. Or an investor may invest in blue chip stocks as well as small cap stocks.

Risk Taking Without Risking All

If you are in your early 20s and just starting to save for retirement, a diversified portfolio can also benefit you. You can choose to allocate only a part of your savings to a potentially risky venture such as a new startup company or overseas investment fund. Using diversification will ensure that your entire portfolio is not at risk.

Steady Income
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Another advantage of a diversified portfolio is that it increases the probability that you will have a steady stream of income. This can be important if you have shortterm goals that must be met, like paying for your child's college education.

Portfolio diversification
'Don't put all your eggs in one basket' is a well-known proverb, which summarizes the message that there are benefits from diversification. If you carry your breakable items in several baskets there is a chance that one will be dropped, but you are unlikely to drop all your baskets on the same trip. Similarly, if you invest all your wealth in the shares of one company, there is a chance that the company will go bust and you will lose all your money. Since it is unlikely that all companies will go bust at the same time, a portfolio of shares in several companies is less risky. This may sound like the idea of risk-pooling, which we discussed earlier in this chapter, and riskpooling is certainly an important reason for diversification. We will use the notion of riskpooling to explain some forms of financial behaviour, but a full understanding of portfolio diversification involves a slightly wider knowledge of the nature of risk than what is involved in coin-tossing. The key difference between risk in the real world of finance and the risk of coin-tossing is that many of the potential outcomes are not independent of other outcomes. If you and I toss a coin, the probability of yours turning up heads is independent of the probability of my throwing a head. However, the return on an investment in, say, BP is not independent of the return on an investment in Shell. This is because these two companies both compete in the same industry. If BP does especially well in attracting new business, it may be at the expense of Shell. So high profits at BP may be associated with low profits at Shell, or vice versa. On the other hand, all oil companies might do well when oil prices are high and badly when they are low. The important matter here is that the fortunes of these two companies are not independent of each other. The fact that the risks of individual investments may not be independent has important implications for investment allocations, or what is now called portfolio theory. Investments can be combined in different proportions to produce risk and return characteristics that cannot be achieved through any single investment. As a result, institutions have grown up to take advantage of the benefits of diversification.

Diversified portfolios may produce combinations of risk and return that dominate nondiversified portfolios. This is an important statement that requires a little closer investigation. That investigation will help to identify the circumstances under which diversification is beneficial. It will also clarify what we mean by the word 'dominate'. Table 2 sets out two simple examples. In both there are two assets that an investor can hold, and there are two possible situations which are assumed to be equally likely. Thus, there is a probability of 0.5 attached to each situation and the investor has no advance knowledge of which is going to happen. The two situations might be a high exchange rate and a low exchange rate, a booming and a depressed economy, or any other alternatives that have different effects on the earnings of different assets. Table 2: Combinations of risk and return

Assets differ in expected return and variability in returns. Part (i) illustrates the return on two assets in two different situations. Asset A has a high return in situation 2 and a low return in situation 1. The reverse is true for asset B. A portfolio of both assets has the same expected return but lower risk than a holding of either asset on its own. In (ii) both assets have a high return in situation 2 and a low return in situation 1. For the risk-averse investor asset A dominates asset B. Consider part (i) of the table. In this case both assets have the same expected return (20 per cent) and the same degree of risk. (The possible range of outcomes is between 10 and 30 per cent on each asset.) If all that mattered in investment decisions were the risk and return of individual shares, the investor would be indifferent between assets A and B. Indeed, if the choice were between holding only A or only B, all investors should be indifferent (whether they were riskaverse, risk-neutral, or risk-loving) because the risk and expected return are identical for both assets. However, this is not the end of the story, because the returns on these assets are not independent. Indeed, there is a perfect negative correlation between them: when one is high the other is low, and vice versa. What would a sensible investor do if permitted to hold some combination of the two assets? Clearly, there is no possible combination that will change the overall expected return, because it is the same on both assets. However, holding some of each asset can reduce the risk. Let the investor decide to hold half his wealth in asset A and half in asset B. His risk will then be reduced to zero, since his return will be 20 per cent whichever situation arises. This diversified

portfolio will clearly be preferred to either asset alone by risk-averse investors. The risk-neutral investor is indifferent to all combinations of A and B because they all have the same expected return, but the risk-lover may prefer not to diversify. This is because, by picking one asset alone, the risk-lover still has a chance of getting a 30 per cent return and the extra risk gives positive pleasure. Risk-averse investors will choose the diversified portfolio, which gives them the lowest risk for a given expected rate of return, or the highest expected return for a given level of risk. Diversification does not always reduce the riskiness of a portfolio, so we need to be clear what conditions matter. Consider the example in part (ii) of Table 2. As in part (i), both assets have an expected return of 20 per cent. But asset B is riskier than asset A and it has returns that are positively correlated with A's. Portfolio diversification does not reduce risk in this case. Riskaverse investors would invest only in asset A, while risk-lovers would invest only in asset B. Combinations of A and B are always riskier than holding A alone. Thus, we could say that for the risk-averse investor asset A dominates asset B, as asset B will never be held so long as asset A is available. The key difference between the example in part (ii) of Table 2 and that in part (i) is that in the second example returns on the two assets are positively correlated, while in the former they are negatively correlated [Note]. The risk attached to a combination of two assets will be smaller than the sum of the individual risks if the two assets have returns that are negatively correlated. Diversifiable and non-diversifiable risk Not all risk can be eliminated by diversification. The specific risk associated with any one company can be diversified away by holding shares of many companies. But even if you held shares in every available traded company, you would still have some risk, because the stock market as a whole tends to move up and down over time. Hence we talk about market risk and specific risk. Market risk is non-diversifiable, whereas specific risk is diversifiable through riskpooling. Box 3 discusses the issue of whether all firms should diversify the activities in order to reduce risk. Beta It is now common to use a coefficient called beta to measure the relationship between the movements in a specific company's share price and movements in the market. A share that is perfectly correlated with an index of stock market prices will have a beta of 1. A beta higher than 1 means that the share moves in the same direction as the market but with amplified fluctuations. A beta between 1 and 0 means that the share moves in the same direction as the stock market but is less volatile. A negative beta indicates that the share moves in the opposite direction to the market in general. Clearly, other things being equal, a share with a negative beta would be in high demand by investment managers, as it would reduce a portfolio's risk. The capital asset pricing model, or CAPM, predicts that the price of shares with higher betas must offer higher average returns in order to compensate investors for their higher risk.

For any given market condition there is a trade-off between risk and return. Investments with higher risk will be priced to offer higher expected returns than those with low risk. Mutual funds Many small investors do not have enough wealth to invest in company shares to gain the benefits of a diversified portfolio. Yet the average return on investing in shares is higher than that on safe assets, such as government bonds or bank and building society deposits. Hence there is a role for institutions that sell small investors a share in a much bigger and more diversified portfolio. Such institutions are generally known as mutual funds. They are like clubs in which savers pool their funds and then jointly own a diversified set of investments. In the UK they are known as unit trusts and investment trusts. Mutual funds play an important role in helping small investors to achieve international diversification. Just as diversification across UK companies is beneficial in improving the riskreturn trade-off, so international diversification improves it still further. Small investors find it difficult and costly to buy and sell foreign shares, but mutual funds are able to access foreign markets and spread the costs over large numbers of investors. Investment opportunities for small investors are thereby greatly enhanced.

Investment Diversification What is Investment Portfolio Diversification? Investment portfolio diversification is a portfolio strategy combining a variety of assets to reduce the overall risk of an investment portfolio. Portfolio risk consists of two types, systematic risk and unsystematic risk. Systematic risk is the risk associated with market returns. Sources of systematic risk would be macroeconomic factors such as interest rates, inflation, recession, wars, etc. that affect the entire market. Unsystematic risk is company specific or industry risk. This risk can be nearly diversified away. Examples of Diversification Asset Allocation Strategies to Mitigate Systematic Risk

Systematic, or market risk, can be partially mitigated in an investment portfolio through asset allocation. Asset allocation involves dividing specific percentages of an investment portfolio among different markets and classes. Asset categories such as equities, bonds, cash, and alternative investments may not move in the same direction at the same time. Owning a Variety of Industries and Stocks to Mitigate Unsystematic Risk Unsystematic risk is the risk specific to a particular company or industry. You never know when something negative might happen even to the best companies or industries. Diversification can lower the risk (volatility) of an investment portfolio because not all industries or stocks move together. Unsystematic risk can nearly be eliminated by holding a variety of noncorrelated assets. In other words, if an investor owns many non-correlated investments, the harm done by one company or industry having an unwelcome experience will be minimized. Diversification Advantages The advantages of diversification are risk management and portfolio optimization. Risk management is one of the keys to successful investing. If you lose 50% of your portfolio, it takes a 100% gain to get back to breakeven. If you lose 10% of your portfolio, it only takes an 11% gain to get back to breakeven. Diversification through asset allocation may be the most important investment strategy an investor can master. Portfolio optimization is achieved by placing a larger percentage of high return investments in a diversified portfolio. Because proper diversification lowers the overall risk of a portfolio, a portfolio manager can place more aggressive assets in the portfolio. In other words, a portfolio manager, willing to take a given amount of risk, can invest more aggressively with a properly diversified portfolio as opposed to a non-diversified portfolio. Investment portfolio diversification is the strategy of combining assets in such a way as to reduce the overall risk of a portfolio. Examples of how to achieve investment diversification are asset allocation and owning a variety of industries and stocks. The advantages of diversification are lowered overall portfolio risk without lowering portfolio returns. Related Reading: Why Tactical Asset Allocation is Changing the Investment World Please Share! digg 0

INTERNATIONAL FINANCIAL MANAGEMENT

(COURSE22)

International Finance vs. Domestic Finance


International finance is different from domestic finance in many aspects and first and the most significant of them is foreign currency exposure. There are other aspects such as the different political, cultural, legal, economical, and taxation environment. International financial management involves into a lot of currency derivatives whereas such derivatives are very less used in domestic financial management.

The term International Finance has not come from Mars. It is similar to the domestic finance in many of the aspects. If we talk on a macro level, the most important difference between international finance and domestic finance is of foreign currency or to be more precise the exchange rates. In domestic financial management, we aim at minimizing the cost of capital while raising funds and try optimizing the returns from investments to create wealth for shareholders. We do not do any different in international finance. So, the objective of financial management remains same for both domestic and international finance i.e. wealth maximization of shareholders. Still, the analytics of international finance is different from domestic finance. Following are the major differences: Exposure to Foreign Exchange: The most significant difference is of foreign currency exposure. Currency exposure impacts almost all the areas of an international business starting from your purchase from suppliers, selling to customers, investing in plant and machinery, fund raising etc. Wherever you need money, currency exposure will come into play and as we know it well that there is no business transaction without money. Macro Business Environment: An international business is exposed to altogether a different economic and political environment. All trade policies are different in different countries. Financial manager has to critically analyze the policies to make out the feasibility and profitability of their business propositions. One country may have business friendly policies and other may not. Legal and Tax Environment: The other important aspect to look at is the legal and tax front of a country. Tax impacts directly to your product costs or net profits i.e. the bottom line for which the whole story is written. International finance manager will look at the taxation structure to find out whether the business which is feasible in his home country is workable in the foreign country or not. Different group of Stakeholders: It is not only the money which along matters, there are other things which carry greater importance viz. the group of suppliers, customers, lenders,

shareholders etc. Why these group of people matter? It is because they carry altogether a different culture, a different set of values and most importantly the language also may be different. When you are dealing with those stakeholders, you have no clue about their likes and dislikes. A business is driven by these stakeholders and keeping them happy is all you need. Foreign Exchange Derivatives: Since, it is inevitable to expose to the risk of foreign exchange in a multinational business. Knowledge of forwards, futures, options and swaps is invariably required. A financial manager has to be strong enough to calculate the cost impact of hedging the risk with the help of different derivative instruments while taking any financial decisions. Different Standards of Reporting: If the business has presence in say US and India, the books of accounts need to be maintained in US GAAP and IGAAP. It is not surprising to know that the booking of assets has a different treatment in one country compared to other. Managing the reporting task is another big difference. The financial manager or his team needs to be familiar with accounting standards of different countries. Capital Management: In an MNC, the financial managers have ample options of raising the capital. More number of options creates more challenge with respect to selection of right source of capital to ensure the lowest possible cost of capital. There may be such more points of difference between international and domestic financial management. Mentioned above are list of major differences. We need to consider each of them before taking any decision involving multinational financial environment.

INTERNATIONAL BUSINESS ENVIROMENT


Causes OR Problem Discussion and research purpose

(COURSE-19)

Recession in the West, specially the United States and Europe has significantly affected Indian IT companies which depends upon the outsource projects from these countries. The IT projects are a part of planned expenses for future growth of business. In this period, many US/UK based companies had cut-down on their IT expenses. This had a significant impact on Indian IT industry. IT companies has taken various steps to control their outgoing. With this study, we will try to find out how the cost component been managed by Indian IT companies and what are the impacts of such a strategy on their business. In IT Industry, cost of employees package makes a major part of expenses. Many companies come with the concept of virtual bench, fired highly paid employees, put trainees on project by replacing experienced. The research for this subject is done as an exploratory research project. An Exploratory research provides good insights into the issue, situation or any business ideas. To define the research problem, an exploratory research can be carried out. The problems are formulated clearly in exploratory research and it

aims at clarifying the concepts, gathering explanations and gaining insights. A recession is a decline in a country's gross domestic product (GDP) growth for two or more consecutive quarters of a year. A recession is also preceded by several quarters of slowing down. An economy, which grows over a period of time, tends to slow down the growth as a part of the normal economic cycle. An economy typically expands for 6-10 years and tends to go into a recession for about six months to 2 years. A recession normally takes place when consumers revenue. The domestic market is gaining momentum, driven by overall economic growth, increased adoption of technology and outsourcing. Investment Plans of MNCs in India Cost arbitrage and the availability of a large talent pool have attracted several MNCs to India. Big players like IBM, Accenture, CapGemini and Oracle among others have not only increased their headcounts in India but also outperformed their global performance in terms of revenue growth. Their Indian operations are witnessing strong growth as compared to their global business. Some of the major global companies like Intel, IBM and CSC are shifting their base to India.

How it affects India Buyers will aggressively move toward off-shore destinations and service providers that can offer a global delivery model to access lower-cost IT labor for routine IT work that must continue for the business to operate. However, noncritical projects may be delayed indefinitely, and for most organizations, any discretionary IT spending will be cancelled", said Allie Young, vice president and distinguished analyst at Gartner. "Plenty of opportunities are available in Latin America, Japan, China, Europe and also in some African nations," Ganesh Natrajan, Chairman of Nasscom added, urging the IT industry leaders to not be constrained by just US markets, but look elsewhere too. "By 2020, India can alone fulfill the need of technical talent of the whole world. By that time the whole world would need 43 billion technocrats while India will have 47 billion surplus technocrats. Huge investments have to be made to train the available talent," he added. At a time when customers in the US and Europe are tightening their IT budgets, leading Indian tech firms are betting on their huge pile of cash to steer

through the global economic crisis and also to explore M&A opportunities in a world reeling under severe liquidity crunch. Larger spends on training, R&D, a focus on consulting and higher value services could be the only way out for the IT services players. In turbulent times, clients expect greater flexibility and business value from service providers. The tighter governance and regulatory environment that will evolve as a result of the financial turmoil will offer opportunities to service providers in the medium to long-term.

Conclusions
The size of the Indian IT industry, according to NASSCOM, is US$ 64 billion as of year 2008. It has been growing with an annual rate of 28% since 2001. It contributed over 5.5 % of the overall GDP of India. IT Exports will account for 35% of the total exports from India. As far as job creation out of this growth is concerned the sector generated 2 million direct jobs and around 7-8 million indirect jobs. As per the Nasscom forecast in June-July 2008, software exports are projected to grow by $9 billion to $50 billion in fiscal 2008-09 from $41 billion in fiscal 200708 and $32 billion in fiscal 2006-07. As per the McKinsey report, exports are set to touch $60 billion by fiscal 2009-10 even if the growth rate remains lower at 23-

25 percent. The recession hit every country and industry including India and its IT industry. The Indian IT industry largely constitutes Software exports like off-shore support, near-shore support. Major Indian IT companies like Infosys, TCS and Wipro, etc. survived this tough business time by getting local IT contracts. Indian IT industries are adopting innovative ways to beat the heat of recession.