Risk Management & Decision Analysis

Question 1

What is the difference between risk and uncertainty?

Answer 1

Risk involves quantifiable probabilities of outcomes, allowing for statistical management, whereas uncertainty involves unknown probabilities, requiring management through assessment of complex, interdependent factors.

Question 2

How do you calculate expected values in decision making?

Answer 2

EV = Sum of (Probability of Outcome x Value of Outcome)

Question 3

What steps are involved in creating decision trees?

Answer 3

• Identify each decision and possible outcome
• Branch out probabilities and outcomes for each decision point
• Attach costs and payoffs at each end node
• Calculate expected value for decision paths to determine best strategy

Question 4

What are the three management attitudes to risk?

Answer 4

• Risk seeking
• Risk averse
• Risk neutral

Question 5

How do management attitudes towards risk affect decision making?

Answer 5

Risk seeking managers may pursue higher gains through riskier decisions, and vice versa. Risk neutral managers focus solely on the returns disregarding the risk level.

Question 6

What are the advantages of using decision trees in management?

Answer 6

• Provide a clear, visual representation of decision paths
• Help quantify decision outcomes
• Allow easy calculation of expected values