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

Only on StudentShare

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 ...Show more

Summary

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…
Author : scorkery
Save Your Time for More Important Things
Let us write a custom essay on your topic
""Critically discuss the use of standard deviation as a risk indicator for investment purposes?""
with a personal 20% discount.
Find out more

Related Essays

Standard Deviation as a Risk Indicator for Investment Purposes
Over the years, experts have come up with various portfolios in order to allow the investors and observers to determine, manage and minimize the risk associated with certain investments. Standard deviation is one of those tools, which are used widely for risk management of investment portfolios (Crouhy, Galai & Mark, pp, 44-45, 2006; Martellini, Priaulet & Priaulet, pp.
4 pages (1000 words) Essay
Investment Risk Management
Research indicates that, Lehman Brothers Holding Company was one of the four largest mortgage financial institutions in the world its headquarters were based in New York. Connectively, the company had subsidiaries such as; Eargle parners, Aurora, the bank of Lehman Brothers, Crossroads and Group SIB Corporation of Mortgage among others.
5 pages (1250 words) Essay
The Impact of Lobbying on Standard Setting in Accounting
The lobbying involves the activities that businesses carry out for the intention of influencing the government or providing advice to other businesses on how to influence the government. Within the United Kingdom, government includes the central government, local government, and the devolved government.
9 pages (2250 words) Essay
Critically examine and discuss the impact of lobbying on standard setting in accounting. Illustrate your discussion / your analy
The Securities and Exchange Commission (SEC) overviews the functions of the FASB in line with its objective of ensure a level playing ground for the public investors. The chairman of SEC is selected through political appointment by the federal government (Amershi, Demski and Wolfson, 1982, p.22).
8 pages (2000 words) Essay
Standard deviation in portfolio management: A look at Dubai Financial Markets Stocks
The key idea is that when measuring the standard deviation one is able to measure the volatility of the stock. A more volatile stock is one where the stock’s returns have a higher variation from the stock’s
6 pages (1500 words) Research Paper
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.
Systematic risk is applicable to all sectors and industries in a market and just too specific industry. The systematic risk cannot be controlled through diversification.
6 pages (1500 words) Essay
Find out how much would it cost
to get a custom paper written by a pro under your requirements!
Win a special DISCOUNT!
Put in your e-mail and click the button with your lucky finger
Your email
YOUR PRIZE:
Apply my DISCOUNT