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Standard Deviation Finance and Accounting Essay
Finance & Accounting
Pages 4 (1004 words)
Standard deviation is used as one of the indicators of risk of an investment such as a stock or a fund. 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 returns over a given time period.
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%. ...
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