Impact of Mathematics in Finance - Essay Example

For instance, while making decisions regarding investment and financing, the finance managers seek to achieve the right balance between risk and return. If the firm borrows heavily to finance its operations, then the surpluses generated out of operations would be sufficient to service the debt in the form of interest and principal payments. The surplus or profit available to the owners would be reduced because of the heavy 'Debt - servicing'. If things do not work out as planned and the firm is unable to meet its obligations, the company is even exposed to the risk of insolvency.

Similarly, the various investment opportunities have a certain amount of risk associated with the return and also the time when the return would materialize. The Finance manager has to decide whether the opportunity is worth more than its cost and whether the additional burden of debt can be safely borne. In fact, decision making in all areas of management including financial management involves balancing off the trade-off between risk and return. The discovery of the concepts of Variance and Standard Deviation had enabled the financial managers to make more effective decisions in their fields (Steven, 2004).

The Standard deviation is a measure of the dispersion of forecast returns when such returns approximate a normal probability distribution. It is a statistical concept and is widely used to measure the risk of holding a single asset. The standard deviation is derived so that a high standard deviation represents a large dispersion of return and is high risk and a low deviation is a small dispersion and represents a low level of risk. Basically, the standard deviation is the square root of the variance ( Variance is computed as the average squared deviation of each number from its mean).

Because of its mathematical traceability, the standard deviation is a useful measure of the spread in a set of data.