Chapter 9 - Risk and Uncertainty

Question 1

What is risk?

Answer 1

the variability of possible returns

Question 2

What is risk management?

Answer 2

the process of understanding and managing the risks that an organization is inevitably subject to.

Question 3

What is uncertainty?

Answer 3

there are a number of possible outcomes but the probability of each outcome is not known

Question 4

What are the 3 research techniques to reduce uncertainty?

Answer 4

Desk research
Feild research
Focus group

Question 5

What is desk research?

Answer 5

obtaining existing data by studying published and other available information e.g., press articles

Question 6

What is field research?

Answer 6

Information collected from primary sources by direct contact with a targeted group

Question 7

What is a focus group?

Answer 7

Small groups interviewed to gather their opinions and reactions to a particular subject

Question 8

Other methods of dealing with risk and uncertainty include what?

Answer 8

• sensitivity
• simulation
• expected vlaues
• maximax, maximin, minimax regret
• decision trees

Question 9

What is sensitive analysis?

Answer 9

takes each uncertain factor in turn, and calculates the change that would be necessary in that factor before the original decision is reversed.

Question 10

What is simulation?

Answer 10

a modeling technique that shows the effect of more than one variable changing at the same time

Question 11

What is an expected value?

Answer 11

weighted average of all possible outcomes. Calculates the average return that will be made if a decision is repeated again and again.

Question 12

What is the calculation for the expected value?

Answer 12

EV = SUM px

Question 13

What are the advantages of expected values?

Answer 13

• takes risk into account by considering the probability of each outcome
• easier decisions
• simple

Question 14

What are some disadvantages of expected values?

Answer 14

• probabilities used are usually very subjective
• merely a weighted average so has little meaning
• no indication of dispersion

Question 15

What is a payoff table?

Answer 15

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

Question 16

What 2 factors should be considered when doing payoff tables?

Answer 16

• demand (forms axis)
• supply (forms the other axis)

Question 17

What is risk adverse?

Answer 17

aim for the best possible outcome in the worst-case scenario - Maximin

Question 18

What is risk neutral?

Answer 18

Ignore the range of outcomes and aim for the highest EV - EV

Question 19

What is risk seeker?

Answer 19

Aim for the best possible outcome in the best scenario - Maximax

Question 20

What is the maximax rule?

Answer 20

• involves selecting the alternative that maximises the maximum payoff achievable

Question 21

What is the maximin rule?

Answer 21

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

Question 22

What is the minimax rule?

Answer 22

one that minimises the maximum regret. Pick the worst outcome

Question 23

What is a decision tree?

Answer 23

a diagrammatic representation of a multi-decision problem, where all possible courses of action are represented

Question 24

when should decision trees be used?

Answer 24

where a problem involves a series of decisions being made and several outcomes arise