Understanding Risk and Diversification in Corporate Finance

CORPORATE FINANCE
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PART 1
Question 1
A key parameter of a share is the underlying risk which essentially is an indicator of the
volatility in prices. The appropriate measure in this regards would be the standard deviation.
This is essentially used to capture the dispersion of the stock returns about the average stock
returns during a given period. Higher the standard deviation i.e. deviation from the mean,
higher would be the risk associated with the underlying share.
The standard deviation is quite useful in the backdrop of normal distribution. This is because
in a normal distribution, the values around the mean are scattered in a fixed pattern. In
accordance with the empirical rule in normal distribution, the percentage values tend to
follow the distribution indicated in the diagram below1.
Based on the above distribution, it is possible to estimate the likelihood or probability of a
given return in the stock based on the empirical performance of the stock. As a result, the
dispersion of the stock is quite useful in estimating the likely chances of future returns in the
stock2.
Question 2
1 Pettit, Justin. Strategic Corporate Finance. (Melbourne: John Wiley & Sons, 2015) 63.
2 Ryan, Bon. Corporate Finance and Valuation. ( Sydney: Cengage Learning, 2016) 89-92.