7 Risk and uncertainty Flashcards
What is risk?
There are a number of possible outcomes and the probability of each is known
What is uncertainty?
There are a number of possibly outcomes and the probability of each is unknown
What are focus groups?
A common market research tool invoking small groups selected from the broader population.
What are the problems with focus groups?
- results are qualitative
- the sample size may mean that results are not a good representative
- individuals may feel pressure to agree with other members
- their cost and complexity is cited as a barrier, especially for smaller companies.
What is desk research?
Information is collected from secondary sources, it obtains existing data by studying published and other available sources of information. Usually eliminates the need for extensive field work
What factors should be considered when using desk research?
It may not be exactly what the researcher needs or up to date
It is cheaper and quicker than field research
What is market intelligence?
Information about a companies present or possible future markets
What is economic intelligence?
Defined as information relating to the economic environment within a company operates.
What is field research?
Information is collected from primary sources by direct contact with a target group, it is expensive but accurate and up to date.
What are the two types of field research?
Motivational research and measurement research
What is motivational research?
The objective is to understand factors that influence why consumers do or do not products
What are some types of ways to complete motivational research?
Depth interviewing
Group interviewing
Word association testing
Triad testing
What is depth interviewing?
Undertaken at a length by a trained person who is able to appreciate conscious and unconscious associations and motivations and their significance
What is group interviewing?
Where between six and people are asked to consider the subject under trained supervision
What is word association testing?
On being given a word by the interviewer, the first word that comes to mind of the person tested is noted
What is triad testing?
Where people are asked which out a given three items they prefer
What is measurement research?
The objective here is to build on the motivational research by trying to quantify the issues involved
What is random sampling?
Where each person in the target population has an equal chance of being selected. (May be unfeasible in practice)
What is quota sampling?
Where samples are designed to be representative with respect to pre selected criteria
What is panelling?
Where the sample is kept for subsequent investigations so trends are easier to spot
What is observation?
Though the use of cameras within supermarkets to examining how long customers spend looking at a product
What are some common methods of measurement research?
Random sampling Quota sampling Panelling Surveying by post Observation
What is sensitivity analysis?
Takes each uncertain factor in turn and calculates the chain that would be necessary in that factor before the original decision is reversed
What is the process for sensitivity analysis?
1 best estimates for variables are made and decision arrived at.
2 Each of the variables is analysed in turn to see how much the estimate can change before the original decision can be reversed.
3 Estimates for each variable can then be reconsidered to assess the
likelihood of the estimate being wrong
4. The maximum possible change is often expressed as a percentage.
This formula only works for total cash flows
What are the strengths of sensitivity analysis? (3)
- There is no complicated theory to understand.
- Information will be presented to management in a form which facilitates
subjective judgement to decide the likelihood of the various possible
outcomes considered. - It identifies areas which are crucial to the success of the project. If the
project is chosen, those areas can be carefully monitored.
What are the weaknesses of sensitivity analysis? (3)
- It assumes that changes to variables can be made independently, .
- It only identifies how far a variable needs to change; it does not look at
the probability of such a change. - It provides information on the basis of which decisions can be made but it does not point to the correct decision directly.
What is simulation?
A modelling technique that shows the effect of more than one
variable changing at the same time.
When is simulation often used?
Capital investment appraisal.
What is the Monte Carlo simulation method?
Uses random numbers and probability statistics. It can include all random events that might affect the success or failure of a proposed project.
What are the drawbacks of simulation? (4)
- It is not a technique for making a decision, only for obtaining more
information about the possible outcomes. - Models can become extremely complex.
- The time and costs involved in their construction can be more than is
gained from the improved decisions. - Probability distributions may be difficult to formulate.
What is expected values?
An expected value is a weighted average of all possible outcomes. It
calculates the average return that will be made if a decision is repeated
again and again.
What is the formula for expected value?
The formula for the expected value is
EV = Σpx
What is expected values useful for?
It is a useful decision rule for a risk neutral decision maker
What are the advantages of expected values? (3)
- Takes uncertainty into account by considering the probability of each
possible outcome and using this information to calculate an expected
value. - The information is reduced to a single number resulting in easier
decisions. - Calculations are relatively simple.
What are the disadvantages of expected values? (3)
-The probabilities used are usually very subjective.
-The EV is merely a weighted average and therefore has little meaning
for a one
off project.
-The EV gives no indication of the dispersion of possible outcomes
about the EV, i.e. the risk.
-The EV may not correspond to any of the actual possible outcomes.
Why is a pay off table useful?
It is a useful way to represent and analyse a
scenario where there is a range of possible outcomes and a variety of
possible responses.
What does a pay off table illustrate?
A pay
off table simply illustrates all possible
profits/losses.
What is maximax?
The maximax rule involves selecting the alternative that maximises the maximum pay off achievable.
Who is maximax aimed for?
Suitable for an optimist, or ‘risk
seeking’ investor,
who seeks to achieve the best results if the best happens
What is maximin?
The maximin rule involves selecting the alternative that maximises the
minimum pay
off achievable.
Who is maximin aimed for?
This approach would be appropriate for a risk
averse pessimist who seeks
to achieve the best results if the worst happens.
What is the minimax regret rule?
The minimax regret strategy is the one that minimises the maximum regret
Who is the minimax regret rule useful for?
It is useful for a risk
averse decision maker. Essentially, this is the technique for a sore loser who does not wish to make the wrong decision.
What is a decision tree?
A decision tree is a diagrammatic representation of a multi
decision problem, where all possible courses of action are represented, and every
possible outcome of each course of action is shown.
When should decision trees be used?
Decision trees should be used where a problem involves a series of
decisions being made and several outcomes arise during the decision
making process
What does a decision tree force the decision maker to do?
Consider the logical sequence of events
What is perfect information?
The forecast of the future outcome is always a correct
prediction. If a firm can obtain a 100% accurate prediction they will always
be able to undertake the most beneficial course of action for that prediction.
What is imperfect information?
The forecast is usually correct, but can be incorrect. Imperfect information is not as valuable as perfect information.
How is the value of information calculated?
Expected profit (outcome) WITH the information LESS Expected profit (outcome) WITHOUT the information
