Final answer:
Business risks differ across industries due to unique factors inherent to each sector. To mitigate these risks, strategies like loan diversification are employed by banks, balancing losses from defaults across various sectors. However, diversification has limits, especially during widespread economic recessions.
Step-by-step explanation:
When we say business risks may vary from industry to industry, it means the potential for loss or adverse outcomes that businesses face differs based on the economic sector they operate in. Each industry has unique risk factors related to its specific operational environment. For instance, the risks in manufacturing cars substantially differ from those in creating software or providing services such as haircuts or fast-food meals. To mitigate these risks, businesses and financial institutions employ strategies like diversification.
Banks can protect against high rates of loan defaults and asset-liability time mismatches by diversifying their loans across various consumers, firms, industries, and geographic areas. Diversification balances out the potential losses from one sector with gains or stability from others. Even though diversification is a powerful risk management tool, it has limitations, such as being less effective during a widespread economic downturn that affects multiple sectors simultaneously.
Similarly, individuals investing in stocks or bonds are advised to diversify their investments. By not putting 'all eggs in one basket' and spreading investments across various companies and industries, they can protect themselves from the risk of any single company's failure significantly impacting their financial health.