Question

Question #1

Investment Advisors must understand the investment valuation risks associated with a security before making recommendations to their client.

Answer the following questions regarding investment risks.

1. List and describe, in your own words, the three (3) methods used by analysts to measure the volatility of an investment.
2. Explain how a “bell curve” diagram helps investors to measure a stock’s price volatility.
3. Explain, in your own words, how “duration” is used to measure volatility in fixed income securities.

Answer 1

Analyst measure the volatility of an asset class like equities using following :

1. Beta which gives the current variance and deviation using past volatility
2. Volatility using black scholes theorem in which future volatility is predicted
3. Past volatility using simple normal distribution method and alpha, beta and gamma.

Bell curve diagram helps understand volatility of stock by understanding the values and fluctuating movements at doffernet intervals and different time periods and thus helps identify volatility at peak amd trough events or changing business cycles.

Duration is used in fixed income security like bonds, debentures and commercial papers to asses volatility. For example a AAA+ rated corporate bond with longer duration can withstand business cycle and hence volatility is low while an ultra low duration commercial paper can default on high risks and hence high volatility due to lower time amd lower adjustability.

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