Average prices are used to identify a median or average number as a benchmark for evaluating a security’s performance or creating budgets. This approach can be used for expenses, bond issues, and stock options to determine stability and performance over an extended period.
Average prices are measures of price ranges that take into account the overall range and identify a median or average number that serves as a benchmark for evaluating a security’s performance. The process requires identifying the values involved, adding them up, and then dividing the sum by the number of prices or values that were included in the range. The average price can be compared to the current market price of a security, making it possible to determine if the investment is currently being made above or below par. This same approach can also be useful in creating budgets for a future period, based on the averages of various expenses in previous periods.
When using an average price as a budgeting tool, the process begins by identifying the expenses associated with a specific item that occurred within a defined time frame. For example, if an individual is writing a household budget for the coming year and wants to set the monthly budget for utilities, he or she would add up the monthly utility totals, arriving at a sum that defines the total cost of utilities for year . To get the average price of utilities for that period, that yearly total would be divided by twelve. The resulting average price could be used to set the monthly utility budget for the next year.
The same basic approach is used to calculate the average price associated with a bond issue. Here, the current face value of the bond is added to the actual price the investor paid for the bond. That sum is divided by two to determine the geometric mean where the average price exceeds the purchase price as the bond approaches maturity. Calculating the average aids in the task of tracking the yield to maturity or YTM of the bond, although most investors will not rely on this approach alone to determine the YTM.
Investors can also use the average price model to identify the average annual movement of a stock option over the past five to ten years. The ten-year average can be compared to the actual current market price as a rough estimate of whether the current stock value is below the average of the past ten years or is performing above this benchmark. While determining the average price in this scenario should not be the determining factor in the decision to buy or sell the stock, the calculation provides a rough idea of how the stock will perform over an extended period of time. This will allow the investor to get an idea of the stability of the security, which in turn may prompt the investor to investigate the option further.
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