MINI CASE 7.2
In the world of finance, the buying of stocks and shares can be a risky business. The risk associated with share trading is given by a share's volatility which measures the scale of fluctuations in the price of a share over a past period of time - the higher the volatility, the greater the expectation of either losing or making a lot of money. Volatility is the standard deviation of a shares price movement and can be expressed in absolute terms (e.g. ±25p) but is normally expressed as a percentage of the mean price (the coefficient of variation - see Section 7.5.1). For example a volatility of 20 per cent on a share price of 100p would imply an expectation of price movement of between 80p and 120p. Volatility is not, however, constant and can vary, sometimes quite dramatically, over time as prices react to unexpected events such as bids, profit warnings or external world events.
Volatility will be used by fund managers to match their various investment bonds to investors' behaviour to risk: for the adventurous investor, a bond with a collection of shares that have high volatility might be of interest; for the cautious investor, shares with low volatility would be more attractive.
Public limited companies rely on the investment market to help raise funds. The volatility of its shares can influence the financial markets confidence; the higher the volatility the lower the confidence and consequently, the harder it is to raise funds through selling shares. Additionally, lower price shares tend to have high volatility because even small absolute movements in price show high volatility. In April 2012, the Royal Bank of Scotland (RBS) had a share price of around 24p but with a relatively high volatility - as illustrated in the chart below.
It was announced in the financial press that RBS was proposing to boost market confidence by reducing volatility through increasing its share price from 23p to £2.30. This would be achieved by swapping ten shares for one. Financial analysts were sceptical that this would have the desired effect.
Sources:
How to calculate stock price volatility www.eHow.com
Uk.finance.yahoo.com
Financial Times, 27 April 2012 www.ft.com
The Telegraph, 25 April 2012 www.telegraph.co.uk
The Guardian, 25 April 2012 www.guardian.co.uk