Question

What are methods firms use to diversify risk? What are the methods individuals use? What type of risk taker would you say you are and why? How would time impact the risk you or a firm are willing to take?

Answer 1

Solution

Risk means nothing but uncertainity that of an outcome's occurance.There are generally 2 types of risk - Systematic and Un-Systematic

Business cannot reduce/eliminate of /get rid of Systematic risk .In case of Un-systematic risk,they can reduce it by the principle of diversification.

Ex of Systematic risks : Country/sovereign Risk,Global economic crisis etc.,

Ex: U systematic risks - Company underperformance etc.,

Ex: Investing in different stocks that have different co-relation coefficients (moving by different amounts) is a diversification technique.It is done to minimize the extent of loss.

Business also use the concept of entering into futures and fowards contracts under which the they enter into agreement with their buyers to sell their products to be sold in particular quantity and at a particular price.This is done to eliminate the risk due to foreign currency.

Individuals also use the method of diversification.One of the primary reason of success of Mutual funds is diversification.They invest in a large number of stocks resulting in small % percentage allocation to each stock.This reduces the portfolio risk due to underperformance of single stock.

I am risk-lover because I love to take more risk inorder in the process of achieving high risk. Ex : I would more money if the stock market corrects instead of the conservative investors who withdraw / stop investing when the market falls.

As the time period increases,the risk decreases.For Ex: If you take the case of Indian Stock market,any investor who stood invested in stocks for more than 5 years,did not suffer any loss.

But generally the public sees it as the opposite i.e., as the time period increases,the uncertainity increases.

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