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To: Reginald Middleton who wrote (128)	2/8/1999 11:45:00 AM
From: Steve Robinett	Read Replies (2) \| Respond to of 419

Reg, You comment, The investors primary risk is that they will lose money That is the investor's primary fear. The risks in any investment situation are numerous, including the obvious risk due to market fluctuations. You also comment, Raw historical volatility has failed on many occasions to manage risk in the REAL WORLD. Again, depends on the risk. (Also depends on who's doing the managing.) A major pricing component of options is the volatility of the underlying issue. Options are used quit successfully to hedge portfolios against market risk--that's why they exist, for Heaven's sake! They hedge changes in price and changes in price are how investors lose that money. In addition, you comment, Before we go on, I think it is imperative that you see risk as the investor sees it, loss of capital, as compared to fluctuation in that capital which includes reward. It is the mother's milk of investing that risk and reward go hand in hand. Since people buy stocks long and also short stocks, they sell both puts and calls to hedge against those positions without risking loss. More importantly, volatility typically declines as a stock rises in price and shoots up as a stock falls, an expression that investors see the issue as less risky and will consequently take less of a reward for owning it. Understanding volatility beyond the superficial repays the effort, certainly more than making qualitative (subjective) assumptions about risk. If we define risk specifically, we might actually wind up understanding something about it. Best, --Steve

To: Reginald Middleton who wrote (128)	2/8/1999 12:26:00 PM
From: Chuzzlewit	Read Replies (1) \| Respond to of 419

Reginald, I come back to Apratim's observation that we are dealing, in part, with a semantic problem. I think that risk is best defined in terms of the possible consequences of expectations not being met. Traditional theorists tell us that there are two kinds of risk: business risk (which is diversifiable) and market risk which is not diversifiable (but is manageable). While the former risk traditionally consists of issues like losing a major contract or a factory burning down or a strike, it also consists of the possibility that expected growth may not materialize. Look at what happened to CIEN shares after T pulled the plug on their products as an example of this. Market risk consists of the general outlook for the equity markets, and is closely tied to issues like Brazilian economic woes, and long-term interest rates. These are generalized concerns that affect all businesses to some degree, and this is the kind of risk that beta measures. I think the point that you are overlooking is the fact that the residuals are normally distributed, which means that volatility and risk are one and the same. You said that Excluding the last year or two (or three), MSFT has a lower beta and volatility than the S&P 500, although it has trounced it in return over the same period. You are incorrect at least as far as beta (I don't know what the volatility numbers are). The S&P500 has a beta of 1.00 (by definition) and MSFT has a beta well in excess of 1.00. The way you measure beta is to regress the market's periodic rate of return against the stock's periodic rate of return -- not the S&P index against the stock price. When you do this you exclude sudden jolts to the stock price as a result of diversifiable risk (like the effects of the DOJ suit against MSFT). TTFN, CTC