 In this section, I will explain the concept of diversifying principle. So by diversification, we mean that we are putting our money in various types of financial instruments. We are investing our money in multiple things so that we can get our exposure to the risk to a minimum level. So that is basically the concept of diversifying. So when we use this concept of diversification principle, it means that we are putting our money in various types of financial instruments in order to protect ourselves against the possible risks that are associated with any one product. Diversification principle helps us in reducing our exposure to the risk. So we, through this particular technique or following this particular technique, we reduce our exposure to these different types of issues that may come up. Now when we are trying to understand the concept of diversification, we have to understand that what are the various correlated and uncorrelated risks. So I am going to explain to you as an example that if you are investing in a product category, investing in a different type of business, if you do not want to take any other type of business, then it would be better that we have this kind of a situation. Both businesses, because they operate in different areas, if there is a loss in one area, they cannot influence the other business. So in this example, we can understand that the risks that we expose ourselves to, obviously when you invest, you are exposing yourself to multiple types of risks. But by investing your money in two different product categories or two different types of investments, you have exposed yourself to uncorrelated risks. Uncorrelated means that if in any kind of product market or in any sector, there is a problem, a problem arises, a shortage of supply, or a tax has come, or another disease has spread, there has been an issue with raw material availability. So you have invested there, if you have a loss, then in a completely uncorrelated product, if you invest in a company, then you will not have a loss because that is altogether a different area. And the risks there are different, the factors of these risks are different. And by doing this, you do diversification and you can reduce your risk exposure by using the concept of diversification principle. Now I am going to take an example and I will explain the concept of diversification principle using this particular example. Suppose you have $100,000 which you want to invest in a medicine business. And if you want to invest in a medicine business in the same way, then suppose you know the analysis of the market that you have done, that there are 50% chances that your business will be successful, there are 50% chances that your business will flop. So mathematically or statistically we can put it as that probability of success is 0.5, that is 50% chances, and probability of failure of that particular product is again 50%. So in this kind of situation, if we try to elaborate this particular situation with the help of some numbers, we said that if you benefit from investing $1,000,000 and if your product becomes successful, then the profit you will get will be $400,000. That means if you invest $1,000,000, you can benefit from $4,000,000. But if your medicine has flopped in the market and you want to invest, then in that case, you will not be getting anything in return. So if we look at this particular scenario with the help of this particular table, you can see that in the first column, you can see that if the medicine fails, then its probability is 50%. If the medicine becomes successful, then its probability is 0.5%, that means 50%. Now pay off means how much you will get in return. So if your medicine fails, then you will benefit from $0. You will lose all your money. But in case if the medicine becomes successful, you will benefit from $4,000,000. You will get $4,000,000. Now if we calculate the rate of return which is given by this small rj, we learned the formula of calculating the rate of return first. How do we calculate this? The rate of return is basically the payoff you have taken. If you minus the total investment of your cost from this payoff, and then divide it from the cost, then you will get the rate of return. So what did I do here? $0 minus $1,000,000 divided by $1,000,000 has given me minus 100%. And here I used this formula, that is $400,000 minus $100,000 divided by $100,000. And I have got the rate of return equivalent to 300%. So if your medicine becomes successful, then your rate of return is 300%. If your medicine fails in the market, then the rate of return in that case would be minus 100%. Now if you did not diversify here, then in the next example, I am going to show you that if you would have diversified, if you did not invest all your money in the same business, then in case of failure, you will get some benefit. You will get minus 100% or 100% negative, you will not get the rate of return. So to understand that particular thing, we can see that in case if we would have invested in two drugs, two types of medicines, one is the medicine of blood pressure, the other is the medicine of headache. You do not have to take any of them. Fine. If you would have invested in two medicines, two drugs instead of just one, then for that you can see that if both of your products fail, then its chances are very low, and for that probability you will see that it is just 25%, 0.25%. And if one of the two products becomes successful, then it has 50% chances. Fine. And if both the products become successful, then it has a 25% chance. Now in this case, if both of your products fail, then there are very few chances that both the products fail. So in that case, you will get the payoff of 0 and if you have invested 1 lakh dollars, then you will get the rate of return minus 100%. Now, there are 50% chances that one drug will be successful. In that case, you can get the profit of 2 lakh dollars, which is the rate of return. If we look at it, it can be 100% rate of return. Now, there is another possibility that if your 25% chances are that both of your products become successful, in that case, you will be able to generate a payoff of $400,000. In that case, if you get the rate of return, then it is plus 300%. So now, if we look at these two options, then it becomes a 75% chance. Okay. In the 75% chance, you will get some profit. And the 25% chance, which is a quarter, that means there is no chance that you will get a loss. So when is this possible? Because in this case, we are investing in two drugs. So if you invest in two types of businesses, following the diversification principle, you can see that the probability of you making a loss or likelihood is very low as compared to if you are putting all your money in one type of product or if you invest in one type of product, then there are more chances of you making a loss. As we saw in the last example, when you were investing in only one medicine, then your chances of making a loss were 50%. Yes, chances of making a loss are only 25% because we have diversified. Now, if we look at the advantages of diversification, we have just seen with the help of an example that your probability of loss is cut down to a certain extent. But another thing you have seen is that in case of diversification, your chances of making a loss have decreased but at the same time, when you were investing in one drug, you had 50% chances of making a loss. But here, your chances of making a loss are 0.5% or 50% cut down to 25%. So this is the cost which you will have to pay when you will diversify. So the chance of getting a very high level of profit also goes down but at the same time, the good thing is that your chances of making a loss are also cut down to a certain extent if you invest in a diversification principle.