Podcast
Questions and Answers
What is the primary reason the coefficient of variation is used in investment risk analysis?
What is the primary reason the coefficient of variation is used in investment risk analysis?
If the probability distribution of a security is normal, what percentage of the average expected return will lie within ±1 standard deviation?
If the probability distribution of a security is normal, what percentage of the average expected return will lie within ±1 standard deviation?
What is the correct interpretation of the coefficient of variation?
What is the correct interpretation of the coefficient of variation?
What is the primary difference between systematic and unsystematic risks in a portfolio?
What is the primary difference between systematic and unsystematic risks in a portfolio?
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Which of the following is a correct statement about portfolio risk?
Which of the following is a correct statement about portfolio risk?
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What is the formula to calculate the coefficient of variation?
What is the formula to calculate the coefficient of variation?
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Based on the coefficient of variation, which of the following is a correct conclusion about the risk of FLI and WEB?
Based on the coefficient of variation, which of the following is a correct conclusion about the risk of FLI and WEB?
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What is the purpose of calculating the standard deviation of an investment?
What is the purpose of calculating the standard deviation of an investment?
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What is the relationship between the coefficient of variation and the risk of an investment?
What is the relationship between the coefficient of variation and the risk of an investment?
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What is the correct interpretation of the standard deviation of an investment?
What is the correct interpretation of the standard deviation of an investment?
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Study Notes
Measuring Risk
- Standard deviation is a measure of volatility, showing how much variation exists from the average return of an investment.
- A smaller standard deviation indicates lower risk, while a higher standard deviation indicates higher risk.
Computing Standard Deviation
- Steps to compute standard deviation:
- Multiply expected individual return by probability distribution.
- Subtract expected average return from the return.
- Square the difference.
- Multiply the squared difference by the probability distribution.
- Square the result.
Example: Timbuktu Corporation
- WEB has a better average expected return of 22% and a higher standard deviation of 16.52%.
- FLI has an average expected return of 14.55% and a standard deviation of 11.80%.
Diversification and Portfolio Risk
- Combining two or more assets in a portfolio helps reduce the standard deviation.
- Minimizing risk also depends on the degree of correlation between the assets in the portfolio.
- Combining two perfectly negatively correlated assets can eliminate the overall portfolio risk.
- Combining two perfectly positively correlated assets does not reduce the risk.
Coefficient of Variation
- The coefficient of variation is a statistical measure of the distribution of data points around the mean.
- It is computed as the ratio of the standard deviation to the mean.
- It is useful for comparing the degree of variation from one data series to another.
- The investment with a higher coefficient of variation is riskier.
Example: FLI and WEB
- FLI has a higher coefficient of variation, making it a riskier asset than WEB.
Portfolio Risk
- Portfolio risk is associated with the total risks of the portfolio, consisting of systematic and unsystematic risks.
- It is not computed by simply obtaining the weighted average of the expected returns of the individual assets in the portfolio.
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Description
Learn how standard deviation measures risk and volatility in investments, and how it indicates the level of risk.
