Diversification is the strategy of combining distinct asset classes in an investment portfolio in order to reduce overall portfolio risk. In other words, diversification is the process of selecting the asset mix so as to reduce the uncertainty in the return of an investment portfolio. Diversification helps to reduce investment risks because different investments may rise and fall independent of each other. The combinations of these assets will nullify the impact of fluctuation, thereby, reducing risk. Most financial assets are not held in isolation, rather they are held as parts of portfolios. Banks, pension funds, insurance companies, mutual funds, and other financial institutions are required to hold diversified portfolios. Even individual investors - at least those whose security holdings constitute a significant part of their total wealth - generally hold stock portfolios, not the stock of a single firm. Why is it so? An important reason is the lowering of risk, which means risk of getting zero or negative return on some assets. If a person holds a single asset, he or she is highly dependent on the issuer firm, its success, and dividend policy, as well as on the overall ...

In the context of an investment, a situation of certainty is one in which the return from the investment is known for sure. Let us say, an individual invests in government securities and holds them to maturity. The individual can be sure about the redemption of the amount invested on maturity and payment of interest. Therefore, his/her rate of return is known for sure. The term risk, in the context of investments, refers to the variability of the expected returns. It is an attempt to quantify the probability of the actual return being different from the expected return. Though there is a subtle distinction between uncertainty and risk, it is common to find the use of both the terms interchangeably. Types of Investment Risk The variability of the return or the risk can be segregated into many components, based on the factors that give rise to it. Broadly, risk is said to be made up of three components: business risk, financial risk and liquidity risk. Let us understand them briefly. Business risk can be easily understood in the context of an investment in a business entity. This risk is the variability of returns introduced by the nature of business of the entity invested in. ...

Man, it is said, lives on hope. But, hope is only a necessary condition for life, but not sufficient. There are many other materialistic things that he needs - food, clothing, shelter, etc. And, like his hope, his needs too keep changing through his life. To make things more uncertain, his ability to fulfill the needs too changes significantly. When his current ability (current income) to fulfill his needs exceeds his current needs (current expenditure), he saves the excess. The savings may be buried in the backyard, or hidden under a mattress. Or, he may feel that it is better to give up the current possession of these savings for a future larger amount of money that can be used for consumption in future. In contrast to the above situation, if the amount available for current consumption is less than the current needs, he has to engage in negative saving, or borrowing. The funds thus borrowed may be used for current consumption. But, the lender of the money who forgoes his current possession and hence its consumption will ask for more than what he has lent. That is. the borrower should be willing to pay more than he has borrowed. This trade off between the amount available ...

An option is a contract, which gives the buyer the right to buy or sell foreign currency at a specific price, on or before a specific date. For this, the buyer has to pay to the seller some money, which is called as premium. There is no obligation on the buyer to complete the transaction if the price is not favorable to him. Whenever a person has an intention to sell foreign currency by paying a premium amount immediately and settling the same on a later date, it is known as a Put Option. Put Option has two parties, one a buyer of a Put Option and other a seller of a Put Option. Example: Mr. A is interested in selling a US Dollar. Spot rate is US$ 1 = 45.50. Mr. A believes that some 15 days down the line, with the budget coming up, the price of the US dollar will decrease. Not wanting to take any chances, he goes to a dealer and purchases a put option for US dollars 1,000 after 1 month. Dealer knowing the Forex market too well, agrees to that but demands Rs. 100 as a risk measure that he is ready to take. So now they enter into a contract whereby Mr. A would pay the dealer Rs. 100 right now and after one month, the dealer would have to take delivery of the US dollar for the ...

Option Trading confers the right on the holder/buyer to buy/sell a specified asset (here foreign currency) on a specific price on or before a specific date but he has no obligation to buy/sell. Seller/Writer has an obligation to fulfill the contract if buyer/holder exercises the option. Whenever a person has an intention to buy foreign currency by paying a premium amount immediately, and settling the same on a later date, it is known as a Call option. Call option has two parties, one a buyer of a Call option and other a seller of a Call option. Example: Mr. A is interested in buying a US dollar. Spot rate is US$ 1 = 45.50. Mr. A believes that some 30 days down the line, with the budget coming up and the price of the US dollar would increase. Not wanting to take any chances, he goes to a dealer and purchases a call option for US dollars 1,000 after 1 month. The dealer, knowing the Forex market only too well, agrees to that but demands Rs. 100 as a risk measure that he is ready to take. So now they enter into a contract whereby Mr. A would pay the dealer Rs. 100 right now and after one month, the dealer would have to take delivery of the US dollar for the agreed amount of US$ ...

Options contracts, as well, must be evaluated to determine their worth. Although like any good or service, supply and demand for, say, options will affect the price; to understand the value underlying the price, we need to look deeper. Just as we would consider such factors as the quantity and quality of earnings, price-earnings ratio, and industry outlook, to determine the value of a firm; so we must use the various performance measures  to analyze options and futures. Their analysis is complicated by their relationship with the underlying instrument. The underlying asset price therefore is a critical ingredient in the valuation or pricing of options. A key ingredient in the pricing of options thus is the relationship of the option or future to the underlying security on or before expiration determines its value. The price of an option or a futures security will always be a function of the price of the underlying asset. This relationship we have noted is called "intrinsic value" and represents the profit, which can be realized if the option were exercised (used) immediately. An option allowing one to sell a share of ABB at Rs. 1000 per share when the cash market price is Rs. ...