4 Responses Oct 22

Laxmikanth Work:

Investors before investing into stocks they will analyze the risk to make decisions. This process involves identifying and analyzing the amount of risk involved in an investment, and either accepting that risk or mitigating it. Risk measures are statistical measures that are historical predictors of investment risk and volatility, and they are also major components in modern portfolio theory (Chen, 2020). Investor needs to determine whether an investment’s potential benefits are worth the risk to your portfolio’s fiscal health. There are five principal risk measures, and each measure provides a unique way to assess the risk present in investments that are under consideration. The five measures include the alpha, beta, R-squared, standard deviation, and Sharpe ratio.

Standard deviation, which can be found in a number of published services, measures a stock's volatility, regardless of the cause. It basically tells us how much a stock's short-term returns have moved around its long-term average return. The most common way to calculate standard deviation is to figure the deviation from an average monthly return over a three-five, or 10-year period and then annualize that number. Higher standard deviations represent more volatility. The standard deviation is used in making an investment decision to measure the amount of historical volatility associated with an investment relative to its annual rate of return (Segal, 2020). When prices swing up or down, the standard deviation is high, meaning there is high volatility. On the other hand, when there is a narrow spread between trading ranges, the standard deviation is low, meaning volatility is low. While standard deviation is an important measure of investment risk, it is not the only one. There are many other measures investors can use to determine whether an asset is too risky for them or not risky. When using standard deviation to measure risk in the stock market, the underlying assumption is that the majority of price activity follows the pattern of a normal distribution.

Based on the above standard deviation description it helps the investors in deciding whether to go for investing on a particular individual stock or not. The smaller the standard deviation, the less risky an investment will be. So based on the value of the standard deviation the investor will be able to measure the risk before investing in the stocks.

References

Chen, J. (2020, August 25). What Are Risk Measures? Retrieved from https://www.investopedia.com/terms/r/riskmeasures.asp

Segal, T. (2020, August 28). Learn the Common Ways to Measure Risk in Investment Management. Retrieved from https://www.investopedia.com/ask/answers/041415/what-are-some-common-measures-risk-used-risk-management.asp

Naren Work:

Common Stock

Common stock is a type of security that shows an individual's ownership in a company. It thus grants holders voting rights within the corporation. Common stock yields more significant gains than other investments but has greater potential risk due to its volatility (Pinches & Kinney, 2019). Liability is, however, limited to the common stock price paid. During company liquidation, holders of common shares are compensated last after creditors and preference shareholders. It is thus vital to consider the measure of risk in this kind of investment decision. Investors use various measuring techniques to determine the level of risk in common stock. Risk is mostly determined using historical data in previous periods. Among some of the risk measuring techniques for common stock are Beta and Standard deviation. The value at risk (VaR) and Sharpe Ration are also used to assess these investment risks.

Beta is one commonly used method of measuring the potential risk in common stock investment. It gives a quick and reliable idea of the pattern and trend of potential relative risk (Kraft & Kraft, 2017). This technique measures common stock risk against the index of the entire market. Beta analyzes the volatility of the common stock and that of the index. In the case of a beta of one, the stock and index volatility is the same. In the case of a 0.5 beta, common stock is half volatile the index.

Using the beta measures, it is easy to identify the investment risk through the shares price change direction. With a beta of 1, the price of common stock is expected to go with the market, while with a beta greater than one, it shows that the price will be more volatile than the market. In the case of less than one, the stock is less volatile than the market.

 

References

Kraft, J., & Kraft, A. (2017). Determinants of common stock prices: a time series analysis. The journal of finance, 32(2), 417-425.

Pinches, G. E., & Kinney, W. R. (2019). The measurement of the volatility of common stock prices. The Journal of Finance, 26(1), 119-125.