Explain the Concept of Risk in the Field of Finance

Question

Examlex · Accepted Answer

The Answer is What is risk in finance? It can have various definitions which may include:
- The chance of loss of capital
- The chance of loss of purchasing power
- Variability of returns
- Failure to seize an opportunity
- Inability to reinvest at the same rate.
Because of this the concept of standard deviation is used in finance to measure risk for individual investments. Standard deviation is a measure of the dispersion of returns from an expected mean.
Standard deviation is based on probabilities. It is a statistical fact for normal distributions that if we know the standard deviation, we know that roughly two-thirds of the actual returns will lie in the range of expected return plus / minus one standard deviation from the expected mean. If we want more certainty about the likely range of returns that could eventuate, we can determine the values of the expected return plus / minus two standard deviations from the expected mean. This will increase the level of confidence in our probability that forecasts of future returns will be (more) accurate from about 66% to about 95%. We can measure this risk for an individual asset (such as a share e.g. Telstra) or for an entire asset class (such as for all Australian shares e.g. S&P / ASX 200).

Explain the Concept of Risk in the Field of Finance

Definitions: