Question

What would you say are some of the implications of the Diversification Principle in investing for individual investors? What about the implication for the leaders and managers of businesses as they manage the various sources of their company's Free Cash Flows?

Answer 1

Q.1

Diversification is a technique, that reduces risk by allocating investments among various financial instruments, industries, and other categories. diversification's aims to maximize returns by investing in different areas that would each react differently to the same event. Most of the investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimizing risk.

there are two type of risk to every company:

1. Undiversifiable
2. diversifiable

undiversifiable, which is also known as systematic or market risk. This type of risk is associated with every company. Common causes include inflation rates, exchange rates, political instability, war, and interest rates. This type of risk is not specific to a particular company or industry, and it cannot be eliminated or reduced through diversification—it is just a risk investors must accept.

Diversifiable. This risk is also known as unsystematic risk and is specific to a company, industry, market, economy, or country. It can be reduced through diversification. The most common sources of unsystematic risk are business risk and financial risk. Thus, the aim is to invest in various assets so they will not all be affected the same way by market events.

Example: Let's say you've got a portfolio of only airline stocks. If it's announced that airline pilots are occurring an indefinite strike which all flights are canceled, share prices of airline stocks will drop. which means your portfolio will experience a visible drop in value.

If, however, you counterbalanced the airline industry stocks with a few of railway stocks, only a part of your portfolio would be affected. In fact, there's a good chance the railway stock prices would climb, as passengers communicate trains as an alternate kind of transportation

Q-2

Financial management is closely associated with accounting. In most firms, both areas are the responsibility of the vice chairman of finance or CFO. But the accountant’s main function is to gather and present financial data. Financial managers use financial statements and other information prepared by accountants to make financial decisions. Financial managers concentrate on cash flows, the inflows and outflows of money . They plan and monitor the firm’s cash flows to make sure that cash is offered when needed.

For most small businesses, income is concentrated on the ins and outs of money from business operations. But there are two other possible sources of money flow for larger businesses, and they are utilized in a income analysis method called Free cash flow (FCF).

Free cash flow includes several other sorts of cash flow additionally to cash from operations, including:

1. Cash flow from investments. Your business might spend or get cash from buying or selling assets utilized in your business. for instance , selling used machinery or vehicles might usher in extra cash.
2. Cash flow from financing is financial activity involved in raising capital (selling shares of stock) and paying it back to investors (in dividends, for example).