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Benefits and Limitations of Portfolio Diversification

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FIN/366 Weekly Overview
Objectives for the Week

• Describe types of risks facing financial institutions.
• Analyze the methods used to measure financial interest risk.
• Determine the differences between interest rates and interest income.

What You Already Know
In Week Two, we discussed the regulation of banks, the functions of the Federal Reserve System, the influence the Federal Reserve System policies have on the U.S. economy and interest rates, and the effects those policies have on financial institutions and markets. Students also gained an understanding of how the Federal Reserve System is structured and how those components interact with one another to maintain the soundness of depository institutions and the growth of the money supply. Also discussed were the individual functions and roles of the Board of Governors, the Federal Open Market Committee, and the regional Federal Reserve district banks. Combining these concepts with the understanding of financial institutions and financial markets, students are now ready to explore the assessment and management of risk.

This Week in Context
In Week Three, students will be introduced to the ten major risks financial institutions face and different ways to assess or measure those risks. Newest among these concerns, is exposure due to technology, both from a technological aspect and an operational perspective. These concepts apply in both the personal and professional arenas. An example of a personal application for these concepts would be personal identification and financial information being stolen from a local bank through computer access achieved by nonbank persons. For professional financial managers, risks may include manipulation of confidential data through off site access by unauthorized persons. Also discussed is the difference between interest rates and interest income and how these concepts influence different financial transactions.

Assignment Overview
In the individual assignment due this week, students explore the reasons behind regulating banks and how that regulation relates to the formation of the Federal Reserve System. Students demonstrate an understanding of the effects Federal Reserve policies have on interest rates, financial markets, and financial institutions. Students are given the opportunity to participate in additional activities that further explore the risks faced by financial institutions and how those risks are measured.
In the Learning Team assignment due this week, students deepen their understanding of the services provided, main source of funding, interactions with financial markets, and how Federal Reserve policies affect financial institutions.


Solution Preview

Portfolio Diversification:

A portfolio is the sum collection of all the investments that have been held by a person or an organization. They can be inclusive of stocks, bonds, real estate and other investments. Portfolio diversification entails the mixing up of the investments so that some risks are eradicated. Diversification is a risk management method that encompasses a wide range of investments in the given portfolio. Since the portfolio in the end can yield higher returns, and pose lower risks in the portfolio, diversification of the portfolio is used to counter this act. It is through the diversification of the portfolio that the unsystematic risks are removed to have positive outcomes (Diversification, 2011).

Evaluating benefits of Portfolio diversification:

The reason why most portfolios are diversified is to protect them from the risk of single securities or class securities. This is why portfolio analysis is inclusive of the assessing of the portfolio as a complete unit rather than the act of depending on security analysis. Through portfolio diversification, one is able to reduce the ...

Solution Summary

The solution evaluates the benefits and limitations of portfolio diversification including risk assessments.