Diversification
- Assume that a firm has a choice of selling air conditioners, heaters, or both of them.
- The probability of it being hot or cold is 5%.
- The firm would be better off by diversification probably.
* 5% probability of hot or cold weather
* If firm sells only heaters or air conditioners their income will be $12,000 or $30,000.
* The expected income would be:
- 1/2($12,000) + 1/2($30,000) = $21,000
* If the firm divides their time evenly between appliances their air conditioning and heating sales would be half of their original values.
* If it were hot, their expected income will be $15,000 from air conditioners and $6,000 from the heaters, or $21,000.
* If it were cold, then their expected income would be $6,000 from air conditioners and $15,000 from the heaters, or $21,000.
* With diversification, the expected income is $21,000 having no risk
* Firms can reduce risk by diversifying among the variety of activities which are not closely related to each other.
* Stock Market
- How can the process of diversification reduce the risk of investing in stock market?
- Can diversification remove the risk of investing in stock market?