Financial Market and product risk

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Financial Market and product risk
. When making a decision to invest, it is advisable to do a risk estimation of the investment before pouring money into a venture which may collapse due to losses. This is because every investor is always yarning to get profits whereby the more the profits, the better the deal. However, finance knowledge indicates that the higher the risk the more the expected gain but this should not blind people to enter a venture without fully analysing the benefits and the losses associated with a venture. Therefore, it is wise to use some measurements which help in the estimation of the risks, gains and losses prior to investing (Brandon, Frank, 2005, 73). This is done by use of several tools. Among these is standard variation which is written about in depth in the following paragraphs. This paper defines standard deviation and how it is calculated. Also details are given on how to calculate standard deviation from a group of data, or variance or even from the mean. In addition, the disadvantages and advantages associated with the use of standard deviation in the estimation of risks for investment purposes are explained. Again, the paper tackles on the alternatives which can be used to curb down the disadvantages associated with risk estimation using standard deviation when some one wants to invest in venture to ensure that the best risk estimation is arrived at allowing fruitful investments
Standard deviation is the measure of the deviation from the average or mean of a set of data. In other words, it is the square root of variance (the dispersion of data). Standard deviation is usually higher in case the data is widely dispersed and vise versa. It is used in finance to measure the volatility of a business. It is used to represent the risk associated with financial securities. Because the increase of the risks is directly proportional to the expected, it can help investors evaluate the best avenues to invest (Schwartz, 2009, p.95). In this respect, standard deviation helps quantify the estimate of the uncertain future of the business or investment gains.
Standard deviation is estimated as the positive square root of variance. Variance on the other hand is a measure of distribution of data whereby it explains how the data lies far or near from the average. It therefore measures the dispersion of data (Nguyen, Robert, 2002, p.8). In terms of calculation, it is the mean of all deviations of a data from the mean itself. Also it is the square of the standard deviation.
The use of standard deviation in the estimation of risks has various advantages. Firstly, it helps one to be able to know and guess the expected returns in a certain investments and be able to decide whether to invest in the business venture or not (Blake, 2000, p.p.12). In other words, it acts as a decision making tool in investment. Secondly, when a person is able to guess the risks, he or she is able to cover for these risks. For example, if you expect a loss of three million, then you can be able to know what premiums to pay in an insurance company so as to secure a cover for your business. Also, it is easy to calculate given the probability values of the returns and/ or losses (Ed, 2000, p.34). In addition, standard deviation’s consideration of the scatteredness of data or values ensures that almost all probabilities for loss and gains are included therefore giving the investor an average clue of the expected risks and returns in a certain business venture which he wants to invest in.
On the other hand, the use of standard deviation in the estimation of investment risks is usually accompanied by many disadvantages. To begin with, it is just an estimate around the mean so those risks which may go beyond the values used to calculate the standard deviation may not be catered for. This may lead to huge unexpected losses which may lead to regrets by the investor. Also, the calculation needs the use of computers since it is very complicated. Therefore, it becomes hard for a computer illiterate person to calculate it (Jan, Schnabel, 2002, p.67). This means it is expensive to calculate in the case where someone has to buy a computer or higher a professional to calculate and interpret for him. In addition, less scattered data usually results to a mean which does not address the reality in the market whereby prices and values of commodities in the market vary. In this case, if the standard deviation is calculated using this mean, it results to figure which is not a representative of the true values in the market and may cause a great loss in case an investor decides to invest having used this standard deviation to estimate the risks involved in this venture. Moreover, the standard deviation does not care about the direction. In case of financial risk estimation, the main aim is to get to know the returns or losses in relation to time. For instance, a five...