INSTRUCTOR’S MANUAL

CHAPTER Statistical Techniques

4 in Financial
Management

Learning Objectives
• Understand the use and importance of statistical techniques in Financial Management
• Understand how the mean, median and mode show the ‘central value’ of data
• Understand how range, variance and standard deviation show how data is ‘spread out’
• Understand how decision-making is dependent on knowing relationship between two or more
variables
• Understand how scatter diagrams illustrate the relationship between two variables
• Use regression analysis to estimate the relationship between two variables

Key Teaching Points

INTRODUCTION
• The modern firm generates a lot of data that is available from the internal processes like production,
sales, inventory, etc.
• Furthermore, the performance of the organization is reflected in the share price if the firm is listed.
• The mass of data hereby generated need to be processed by statistical methods to draw conclusions
and derive relationships between variables.

MEASURES OF CENTRAL TENDENCY

• Central Tendency means the middle point of a set of observations, recorded data or distribution.
• Measures of central tendency are:
(i) Mean
– The arithmetic mean
– The weighted average mean
– The geometric mean
(ii) Median
(iii) Mode

THE ARITHMETIC MEAN

• The arithmetic mean is the sum of the numbers divided by the number of observations.
• The symbol μ (pronounced mu) is used for the mean.
ΣX
• μ = (pronounced sigma) means summation.
NΣ
• X means all the observed values, thus ΣX means summation of all the values and N means the total
number of observations.
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THE WEIGHTED AVERAGE MEAN

• This is a variation of the arithmetic mean; the weighted mean allows us to assign some degree of
importance to each value in the data set.
Σ(w*x) weight attached to each observation
• The weighted mean is defi ned by: μ (w) = where: w =
Σw data set
THE GEOMETRIC MEAN
• When we are dealing with a set of numbers that represent change (for example), and we are trying
to find out the average rate of change, then the arithmetic mean is not the most appropriate way of
looking at an average.
• This measure is known as the Geometric Mean. It is represented by the formula for the data set a1,
a2, a3,…, an.

MEDIAN AND MODE

• The median is the midpoint of a distribution: There are equal number of scores above and below
the median.
• The median can also be thought of as the 50th percentile.
• The mode is the most frequently occurring score in a distribution.

DISPERSION
• Dispersion is a measure of ‘spread’ of a population or of a distribution.
• In addition to central tendency, dispersion allows us to analyse a set of figures better.
• For example, the mean 5 of the set of numbers (4, 6) is more representative than the set (1, 9).
• It allows us to compare the spread of various set of numbers and if necessary avoid the outcome
with higher possibility of spread.
• Once it is determined that the data set is widely dispersed, the decision can be made as to whether
to ignore some extreme values.

Range, Quartiles and Interquartile range

• Range is simply the difference between the largest and the smallest observed values in a data set.
• The median divides the data into two equal sets.
• The lower quartile is the value of the middle of the first set, where 25% of the values are smaller
than Q1 and 75% are larger. Th is first quartile takes the notation Q1. The upper quartile is the value
of the middle of the second set, where 75% of the values are smaller than Q3 and 25% are larger.
This third quartile takes the notation Q3.
• The interquartile range is another range used as a measure of the spread. Th e diff erence between
upper and lower quartiles (Q3– Q1), is called the interquartile range.

Variance and Standard Deviation

• The variance (symbolized by S2) and standard deviation (the square root of the variance, symbolized
by S) are the most commonly used measures of dispersion.
• It is calculated as the average squared deviation of each number from the mean of that data set.
2
• Variance is represented by the formula S2 = Σ(x – x)
– 2
n
• And standard deviation by S = Σ(x – x)
n
• Where:
X = each data of the data set
X = arithmetic mean of the data set
n = the number of observations of the data set
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Properties of Standard Deviation

• Standard deviation is only used to measure spread or dispersion around the mean of a data set.
• Standard deviation is never negative. For data with approximately the same mean, the greater the
spread, the greater the standard deviation.
• If all values of a data set are the same, the standard deviation is zero (because each value is equal to
the mean).

CORRELATION AND REGRESSION

• One of the most fundamental concepts in research, in any field, is the concept of correlation. If two
variables are correlated, this means that you can use information about one variable to predict the
values of the other variable.
• Regression and correlation analysis will show us how to determine both the nature and the strength
of relationship between two variables.
• However, results of the analysis should be viewed with discretion. In certain cases, other factors
can cause a change in both the dependent and independent variables. For example, it may be found
that the sale of jewellery has some correlation with sales of Mercedes Benz cars, but the reality may
be that both are driven by one common factor – rising income levels.

Correlation and Regression Analysis

• The first step in finding out whether there is a relationship between two variables is to examine the
graph of the observed data. This graph is known as a scatter diagram or a scattergram.
• A scatter diagram plotting between entrance exam scores and CGPA obtained is shown on
page 75.
• The objective in simple regression is to generate the best line between the two variables (the tabled
values of X and Y), i.e., the best line that fits the data points. Regression uses a formula to calculate
the slope, then another formula to calculate the y-intercept, assuming there is a straight line
relationship.
• The best line, or fitted line, is the one that minimizes the distances of the points from the line, as
shown on page 75. Since some of the distances are positive and some are negative, the distances are
squared to make them additive, and the best line is one that gives lowest sum or least squares.

Maths of Regression Analysis

• In regression, the equation for the straight line is y = bx + a. Here, a is the y-intercept or constant
and b is the coefficient or slope of the line.
• Formulae for b & a:
(Σxy – NXY)
b=
(Σ x^2 – n X^2)
a = Y – bX
where b = slope of best fitting estimate line
x = value of independent variable
y = value of dependent variable
X = mean of values of independent variable
Y = mean of values of dependent variable
n = number of data points