The ability of diversification to eliminate much of the risk from the asset side of the balance sheet of an FI is the result of choosing assets that are less than perfectly positively correlated.

Question

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Diversification allows the FI to spread its assets across multiple investments that are not perfectly positively correlated, thus reducing the overall risk of the portfolio. This is due to the fact that if one asset performs badly, it will not necessarily affect the performance of the entire portfolio.

The Ability of Diversification to Eliminate Much of the Risk