Financial Investment Analysis - Essay Example

This, particularly, must be challenging for companies with global operations that may have their cash balances fragmented across different geographies, banks, and bank accounts which make accessing cash difficult (Huang 2003). In this regard, this paper seeks to address the issue of efficient diversification as a comprehensive strategy in liquidity and stock return. Liquidity of an asset explains the ease with which an asset can be sold after its purchase without incurring further losses and how risks can be mitigated if not minimized (Baker 2006).

The various losses that could be incurred may be due to the various transaction costs or price changes or poor investment strategies. Thus the main aim of this study shall be to examine how proportionate efficient diversification increases the neutralization of low pricing and promising high returns (Elton et al. 2007). The paper holds that efficient diversification must there is a potential benefit when risky part of portfolio consists of weighted proportions of all possible risky assets. Naive and Efficient Diversification Studies done on investment on stock markets and equity securities have documented the relationship that exists in weighted portfolios (proportionate or otherwise on risky assets).

Broadly speaking, there two causes of uncertainty. Elton et al (2007) note that one of them is risk which relates to broad economic conditions. These include inflation, currency exchange rates, interest rates and business cycle. Interestingly, these macro-economic aggregates cannot be foreseen with implicit surety, yet they impact on the rate of returns. Second, according to them, is a firm-specific influence which affects the organization without obviously affecting other companies (Elton et al. 2007). These include effects such as managerial structure, human resource changes and research and development (Baker 2006).

Obviously when diversification is naively done, for instance adding additional security to a risky portfolio, then this should work to lessen portfolio risk. The implication here is that continued diversification into even other securities more and more decreases the probability of exposition to the specific risk factors of the company, thereby ensuring the falling of portfolio volatility (Jagannathan and Wang 2006). All this happens when it is naive diversification where equally weighted portfolio of many securities is employed (Elton et al 2007).

Inherently, if risks are only firm’s specific means, diversification still reduces the risk to reasonable low levels (Baker 2006).This means that when it comes to a situation where the sources of risks are autonomous and there is spreading of investment into numerous securities, there is negligibility of exposure to specific font of risk. This is what is sometimes referred to the insurance principle (Jagannathan and Wang 2006). Regardless of this however, the tragedy is that in a situation where common risk foundations have impact on all companies, even widespread diversifying fails to eradicate risk.

At this, portfolio standard deviation reduces when securities numbers increases. Despite this, it is never reduced to zero, and thus there must be a market risk/systematic risk, which is attributed to market forces (Jagannathan and Wang 1996). Else how, efficient diversification is often done when weighted portfolios are employed proportionately.