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Chapter 17: Q. 22 (page 426)

Why should a financial investor care about

diversification?

Short Answer

Expert verified

Diversification is important to a business endeavor since it helps to reduce risk.

Step by step solution

01

Definition of Diversification.

Diversification implies spreading your investments rather than placing all of your money in one stock.

02

Explanation of solution.

Diversification is a strategy that prevents cash from being invested solely in one asset. The ability to allocate money to private equities, funds and other investments reduces risk. The goal of any financial investor is to make money. If they invest all of their wealth into one fund, would that fund face any future losses? It will be more likely to lose all at once. That is why investments are distributed across a number of equities so that if the value of one drops, the value of the others rises to compensate and reduce the loss. Though this strategy does not guarantee against loss, it does reduce the risk, and the investor does not suffer.

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Most popular questions from this chapter

Why are banks called “financial intermediaries”?

Calculate the equity each of these people has in his or her home:

a. Fred just bought a house for \(200,000 by putting 10% as a down payment and borrowing the rest from the bank.

b. Freda bought a house for \)150,000 in cash, but if she were to sell it now, it would sell for \(250,000.

c. Frank bought a house for \)100,000. He put 20% down and borrowed the rest from the bank. However, the value of the house has now increased to \(160,000 and he has paid off \)20,000 of the bank loan.

How much money do you have to put into a bank account that pays 10% interest compounded annually to have $10,000 in ten years?

What is the difference between a private company and a public company?

Suppose Ford Motor Company issues a five year bond with a face value of \(5,000 that pays an annual coupon payment of \)150. a. What is the interest rate Ford is paying on the borrowed funds? b. Suppose the market interest rate rises from 3% to 4% a year after Ford issues the bonds. Will the value of the bond increase or decrease?
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