PORTFOLIO THEORY.

In 1952, a gentleman called Henry Max Markowitz, in an article drew attention to a general/common practice of portfolio diversification and demonstrated how an investor can reduce the standard deviation of portfolio returns by selecting securities that do not move exactly together i.e that move in opposite directions. He went further to work out the basic principles of portfolio construction. When considering investment appraisal, the traditional approach is to estimate the stand and deviation. Standard deviation is the variability of the return of the project and since standard deviation measures risk, it could be deduced that it is suitable for risk analysis.
This method is only suitable when considering one project only.
A rational investor will not place his eggs in one basket, he will rather spread them in other to avoid total loss. A rational investor will prefer to commit his funds in as many securities as possible which will collectively form his PORTFOLIO.
A portfolio is the collection of several securities on behalf of an investor. In practice, a rational investor will seek to minimize risk and maximize return, he will prefer the project having the higher return at the same level of risk with another and where two securities have the same return he will select the one with the lower risk.   

        SEPARABILITY THEOREM AND THE INTERIOR DECORATOR
    The separability theorem states that all investor ranging from the risk averse to the cavalier should have the same mix of risky securities in their portfolio. This contradicts the interior decorator school of thought in which a skilled analyst is expected to furnish his client with securities that suit his client's psychology.
The risk under consideration is made up of two parts:
1. Unsystematic Risk.
2. Systematic Risk.

UNSYSTEMATIC RISK
This is also known as diversifiable, unique, specific, residual,idiosyncrati and non market imposed risk. It is caused by events such as:
1. Quality of management I.e bad management.
2. Location.
3. Dependency.
4. Nature of the products.
5. Loss of key personnel.
It is also referred to as avoidable risk.

DIVERSIFICATION : Diversification is a strategy usually adopted by rational investors by spreading and committing their funds in several investments in such a way that if a given line goes bad such as an investor has other business line to fall back on.

TYPES OF DIVISERSIFICATION.
Diversification may take three major forms which include:
1. Concentric Diversification
2. Horizontal Diversification.
3. Conglomerate Diversification.

CONCENTRIC DIVERSIFICATION
This occurs when a business organisation adds new ,but related products or services to the existing ones. The key word here is that the products or services are related e.g Nigerian Breweries PLC produces a range of products/drinks such as Gulder, Star, Maltina and Legend stout. The products revolve around each other, hence the company is undertaking concentric diversification.

HORIZONTAL DIVERSIFICATION: This occurs when a business organisation adds new and unrelated products or services to existing ones but for the present customers. The key word is that, although the products are unrelated, they are meant for the already existing customers, thus avoiding the need to find a new market for goods and services.e.g a tuition house may extend its services by operating a canteen, hairdressing salon e.t.c.

CONGLOMERATE DIVERSIFICATION: This takes place when an organization adds new and unrelated products or services to the existing ones and are not principally intended for the existing customers. An example is John Holt trading, John Holt shipping, e.t.c.

  

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