Chapter 9 - Risk and Uncertainty Flashcards
What is risk?
the variability of possible returns
What is risk management?
the process of understanding and managing the risks that an organization is inevitably subject to.
What is uncertainty?
there are a number of possible outcomes but the probability of each outcome is not known
What are the 3 research techniques to reduce uncertainty?
Desk research
Feild research
Focus group
What is desk research?
obtaining existing data by studying published and other available information e.g., press articles
What is field research?
Information collected from primary sources by direct contact with a targeted group
What is a focus group?
Small groups interviewed to gather their opinions and reactions to a particular subject
Other methods of dealing with risk and uncertainty include what?
- sensitivity
- simulation
- expected vlaues
- maximax, maximin, minimax regret
- decision trees
What is sensitive analysis?
takes each uncertain factor in turn, and calculates the change that would be necessary in that factor before the original decision is reversed.
What is simulation?
a modeling technique that shows the effect of more than one variable changing at the same time
What is an expected value?
weighted average of all possible outcomes. Calculates the average return that will be made if a decision is repeated again and again.
What is the calculation for the expected value?
EV = SUM px
What are the advantages of expected values?
- takes risk into account by considering the probability of each outcome
- easier decisions
- simple
What are some disadvantages of expected values?
- probabilities used are usually very subjective
- merely a weighted average so has little meaning
- no indication of dispersion
What is a payoff table?
can be a useful way to represent and analyse a scenario where there is a range of possible outcomes and a variety of possible responses.
shows all possible profits/losses
What 2 factors should be considered when doing payoff tables?
- demand (forms axis)
- supply (forms the other axis)
What is risk adverse?
aim for the best possible outcome in the worst-case scenario - Maximin
What is risk neutral?
Ignore the range of outcomes and aim for the highest EV - EV
What is risk seeker?
Aim for the best possible outcome in the best scenario - Maximax
What is the maximax rule?
- involves selecting the alternative that maximises the maximum payoff achievable
What is the maximin rule?
involves selecting the alternative that maximizes the minimum payoff achievable.
Investors would look at the worst possible outcome at each supply level and chose the highest
What is the minimax rule?
one that minimises the maximum regret. Pick the worst outcome
What is a decision tree?
a diagrammatic representation of a multi-decision problem, where all possible courses of action are represented
when should decision trees be used?
where a problem involves a series of decisions being made and several outcomes arise
