Evaluating a Security Performance Discussion

Response to peer:

Hi Professor,

In general, two elements should be considered when evaluating a security’s performance: return and risk. While the expected rate of return estimates returns, the standard deviation and coefficient of variation show the dispersion of previous data and so might indicate risk. Each is defined briefly below:
1. The expected rate of return is the unguaranteed amount of money that traders or investors can expect to win or lose while making an investment. To calculate this value, the investment requires previous rates of return (RoR), which are multiplied by their odds of occurrence and then added together.
2. The rate of return standard deviation quantifies the rate of return’s dispersion from its mean. As a result, in the case of historical data, the standard deviation might show the volatility of a security’s rate of return in the past. larger volatility may indicate a larger risk for rates of return.
3. The coefficient of variation is the standard deviation divided by the mean. It is a useful statistic for determining the degree of variation between two or more data sets, even if their means are vastly different.
There are several reasons why forming a portfolio is more favorable than simply taking a security’s standard deviation of rate of return and CV. In general, a portfolio is a collection of financial investments such as bonds, equities, crypto currencies, commodities, cash, and closed-end and exchange-traded funds (ETFs). According to contemporary portfolio theory, the more diverse a portfolio is, the higher the odds of return while taking an acceptable risk. As a result, the proficient risk pivot in modern portfolio theory is defined by the portfolio’s standard deviation. Furthermore, a portfolio’s variation reflects only a percentage of the entire risk of the portfolio and actually stands for the variance (squared standard deviation). In contrast to the standard deviation, the variance does not consider all uncertainties to be risks because uncertainty might also be beneficial to an investor. Finally, in portfolio allocation, the weights and fluctuations of each benefit in a portfolio, as well as their covariance, are considered.

Reference:
Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2022). Fundamentals of corporate finance (13th ed.). McGraw-Hill