Thursday, November 30, 2006

Simplifying financial jargons: Part I

Financial jargons have a stupefying effect on me. And financial "experts" use them to their own advantage to confuse and throttle any more questions from vulnerable people like me.

So I'll try to understand them, one/two at a time, and try to articulate my understanding in the language of a newbie.

I'll start with a word that sounds real awesome and weighty,
standard deviation.

Standard deviation simply means the level of fluctuation. For example if a fund or scrip is showing 10% growth every year, the SD here will be zero. However if the growth in each of the four years is, say -5%, 15%, -1%, 20%, then the SD will be said to be very high.

In other words, SD measures the volatility of the returns of the fund or scrips. A high SD will mean that the returns have been highly volatile or fluctuating in nature.

Another word we get to hear is Beta. Similar to SD, it also indicates the volatility of the fund or scrip. But it is calculated or expressed in comparison with its index or benchmark fund.

For example if the beta of a scrip of sensex is 1.1, it means that the scrip will move 10% more than sensex. Therefore if the sensex moves up by 10%, the scrip will move up by 11%. It also means that if the sensex looses by 20%, the scrip will loose by 22%.

I am also told that these statistical measures are indicative in nature and actual performance may differ from the published data. In theory there is no difference between theory and practice but in practice, there is.

Next I'll take up more terminologies: Sharpe ratio, CAGR, Treynor ratio....get ready for the onslaught!!!

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