Diversification

All three types of risks are relevant for deciding what assets to include in a portfolio, and what debts to have outstanding. (The term portfolio means the collection of assets one owns.)

Anyone holding more than one type of asset has to consider not the risk of each asset taken by itself, but the totality of the risk on various assets and debts jointly. Suppose someone holds stock in a company that is likely to gain from inflation, and stock in another company that is likely to lose from inflation. The riskiness of a portfolio that combines both of these stocks may be less than the riskiness of each stock taken separately. A portfolio consisting of assets that are affected in opposite directions by given future events is less risky than are the assets that compose it when taken individually. Hence a low-risk portfolio need not contain only assets that individually have little risk; sometimes one reduces the riskiness of a portfolio by adding some high-risk assets that offset the risks of other assets in it.

Vocabulary:

default Failure to meet a contractual obligation such as repayment of a loan by a borrower or payment of in­terest to bond holders. In the event of default lenders and bondholders can make claims against the bor­rower or the issuer.

default of Upon default of performance on the part of the customer, the Bank

performance may, at its discretion, realize upon the pledges by formal proceedings or by private sale (General Banking Conditions).

the principal The debtor is expected to repay the principal and the interest.

(of the loan)

lender A lender shouldn't lend money unless he knows what it is going to be used for.

borrower If the borrower does not have an account with the bank, the banker should pay particular attention to the borrower's reasons for not obtaining an advance from his own bank.

UNIT 10: INCOME AND CREDIT

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