Got a tricky question? Receive an answer from students like you! Try us!

"Critically discuss the use of standard deviation as a risk indicator for investment purposes?" - Essay Example

Only on StudentShare
Author : scorkery
Finance & Accounting
Pages 4 (1004 words)


Along with Beta, it is the one of the two widely used indicators for this purpose. Standard deviation measures the variability of an investment’s returns around its average…

Extract of sample
"Critically discuss the use of standard deviation as a risk indicator for investment purposes?"

A greater standard deviation implies a greater volatility. More the volatility, more the risk. Generally, high risk is associated with high returns and high losses. Therefore, a fund with higher average returns and lower volatility is the most preferred option. However, such an ideal situation rarely materializes and the investors have to strike a balance between returns and risk due to volatility. Standard deviation acts as a useful tool in achieving this balance.
Standard deviation is not a failsafe method for risk measurement. Standard deviation has an inherent limitation that it is based on analysis of past data. That is why it is also known as historical volatility. The allocation of assets in a stock or fund in the past may be entirely different from the situation today. Therefore, past performance would not be a suitable indicator of future performance. In this case several external factors would have to be considered and standard deviation may fail to give desired results.
Standard deviation does not give information about the current debt structure of the company. It does not take into account the recent changes. For example, a certain company may have an average debt of 30% of the total capital structure over the past 20 years but suddenly over the past year the company has taken a large amount of debt which has take it to 60%. This would have an impact on the financial condition of the company and stockholders are bound to suffer. However, a standard deviation would still show a decent amount of volatility in accordance with previous debt structure. This leads us to the interpretation that standard deviation alone should never be used as a risk indicator.
Many analysts believe that standard deviation is a measure of volatility and not of risk. This has to do with the fact that risk means different things for different people. For some investors, risk implies losing all of their investment, for others a negative return ...
Download paper

Related Essays

Standard Deviation as a Risk Indicator for Investment Purposes
41, 2003). However, over the years, many experts and researchers have also tried to point fingers at this approach trying to highlight its serious shortcomings. This paper is an attempt to capture a glance of that debate and critically analyze the use of standard deviation as a risk indicator for investment purposes. Discussion Standard deviation, in finance, is one of the widely used indicators of risk associated with any given security such as bonds, stocks, properties, commodities and others. Standard deviation allows the investors to predict and anticipate the behaviour of the security in…
4 pages (1004 words)
Investment Risk Management
Additionally, the company was reported bankrupt on 15th September 2008 and was ranged among the top 22 financial institutions that experienced the world largest bankruptcy (Ross, 2010). This collapse brought a big shock not only to the U.S economy but to entire world. This is because the company provided financial services not only to the affluent individuals and companies but also to the government. Among the services that were rendered by the company include; banking services, equity investments, consultancy services, buying and selling of treasury securities to mention just but a few…
5 pages (1255 words)
Critically examine and discuss the impact of lobbying on standard setting in accounting. Illustrate your discussion / your analy
Within the United Kingdom, government includes the central government, local government and the devolved government. The government may also refer to staff or members of the House of Parliament or a devolved legislature, ministries, officials and public authorities (PRCA, 2013). According to UKPAC (2013), lobbying refers to attempting to influence or advising others to influence the UK Government, devolved administrations, parliament and local governments. Therefore, lobbying refers to all the actions that interested parties carry out so as to influence the rule-making bodies (Frattini, 2007,…
8 pages (2008 words)
Critically examine and discuss the impact of lobbying on standard setting in accounting. Illustrate your discussion / your analy
Thus, it is less likely that chairman would not be influenced by the activities of lobbying in the field of setting accounting standards. The lobbying activities in the field of accounting standard setting is directed at influencing the FASB in providing more flexibility to the firm in their accounting practice with no attention towards the safeguarding the long term interests of the firm as well as the investors (Andre, Cazavan-Jeny, Dick, Richard and Walton, 2009, p.24). The intentions of the lobbies are guided by narrow interests of enhancing short term economic value of the firm by…
8 pages (2008 words)
Standard deviation in portfolio management: A look at Dubai Financial Markets Stocks
It is advisable to measure standard deviation of the stock portfolios returns rather than the range because the former gives a clear volatility measure. It is better to understand the pros and cons of risk in order to understand the importance of carrying out standard deviation on stock portfolios.…
6 pages (1506 words)
Critically evaluate the statement that the objective of portfolio investment is to minimise risk with examples, and discuss the differences between systematic and unsystematic risk.
Unsystematic risk on the other hand is specific to a particular industry and can only b controlled through proper diversification or portfolio management strategy. The following pages describes the two types of risks and critically analyzes the statement that objective of portfolio diversification is to minimize risk.…
6 pages (1506 words)