Case Study on Financial Management Essay Example | Topics and Well Written Essays - 2000 words

Case Study on Financial Management - Essay Example The aim of diversification is to reduce the extreme ups and downs in returns and rather to create a consistent return under different economic and market conditions (McGowan, Collier and Young 1992). There are many different asset classes that are available to an investor when making an investment decision. Depending on the return the investor is looking at, the time horizons that the investor is expecting to reap the benefits in and also the level of risk the investor is willing to accept, he or she can invest in a varying combinations and thus achieve diversification of his or her portfolio. Some of the asset classes that are available to us today are money market funds, bonds funds and equity funds. Money market funds are short-term debt instruments that are very liquid and can be converted to cash easily. Treasury bills and commercial paper fall into this category. The risk of loss is lower and pay higher yields than deposit accounts. Bond funds on the other hand pay a regular income, have a longer maturity period and the actual income can fluctuate during economic upturns and downturns since it is for a longer period of time than the money market funds, however they are rel atively safer than equity funds. Equity funds yield much higher returns than both money market and bonds funds however they can be very volatile in the short term and cause havoc in a portfolio. Therefore it is advisable to invest in them for long-term gain rather than short term gain. Diversification can be further classified into geographic, industry and style diversification as well. By this it is meant that we can diversify our portfolios by equity, bonds and money market funds from different regions and countries - which is known as geographic diversification. Sector or industry diversification is investing in equity and bonds from different industries instead of sticking to one particular industry. Style diversification is investing in a portfolio that has instruments that have short term and long term yields or under valued and over valued stocks or all (Adair, Berry and McGreal 1994). The Addendum gives a detailed description of the different diversification strategies that can be used by an individual when combining two classes of assets and gives an indicative calculation of how risk and rewards are leveraged under each strategy by just changing the weight given to the different