Week 3 - Dealing With Risk Flashcards
What is risk in the context of decision-making?
Risk refers to the extent and likelihood that what is expected to happen will not actually happen.
How does risk differ from uncertainty?
Risk involves identifiable possible outcomes and their likelihood, while uncertainty involves unknown outcomes and likelihoods.
What is specific risk?
Specific risk relates to a particular project and can be reduced by diversification.
What is systemic risk?
Systemic risk cannot be diversified away and is caused by factors common to all activities, such as interest rates and inflation.
What are the three attitudes to risk in project selection?
- Risk Averse: prefers lower downside risk
- Risk Taker: willing to accept higher risk for potential reward
- Risk Neutral: indifferent to the level of risk
Why is risk assessment important in capital investment decisions?
Risk assessment is crucial due to long timescales and the significant impact of potential failure on investments.
What is sensitivity analysis?
Sensitivity analysis involves identifying key factors that affect a project and assessing how changes in these factors influence the project’s viability.
What is the purpose of scenario analysis?
Scenario analysis examines multiple variables simultaneously to provide optimistic, pessimistic, and most likely future outcomes.
Define Expected Net Present Value (ENPV).
ENPV is a weighted average of possible present value outcomes, where probabilities of occurrence are used as weights.
What is a drawback of the ENPV approach?
A drawback is that it can obscure underlying risks and may not represent a feasible value.
What is a risk-adjusted discount rate?
A risk-adjusted discount rate is a higher rate of return required for riskier projects, incorporating a risk premium.
What is the portfolio effect in investment?
The portfolio effect involves holding a range of investments to reduce risk through diversification.
List non-financial factors to consider in investment decisions.
- Political factors
- Human factors
- Risk mitigation factors
- Market factors
- Technical/quality factors
- Supplier and customer relations factors
- Intellectual property factors
- Operational factors
What are ESG considerations?
ESG refers to environmental, social, and governance factors that influence sustainability performance in investments.
What is the significance of sustainability in investment decisions?
Sustainability is increasingly important due to public awareness of environmental and social impacts.
What are the 17 Goals of the UN Sustainability Development Goals?
The 17 Goals aim to address global challenges such as poverty, inequality, climate change, environmental degradation, and peace and justice.
What is the impact of greenhouse gas emissions on investment?
Greenhouse gas emissions from activities like burning fossil fuels can lead to environmental challenges, influencing investment decisions.
What is the importance of understanding the downside risk of a project?
Understanding downside risk helps decision-makers assess potential negative outcomes and make informed investment choices.
What is the ‘Zero NPV’ approach in sensitivity analysis?
The ‘Zero NPV’ approach assesses the point at which a project’s NPV is zero, indicating break-even status.
What are the steps in conducting a sensitivity analysis?
- Calculate the NPV of the project
- Change key inputs to see their impact on NPV
True or False: Sensitivity analysis provides clear decision rules for project acceptance.
False. It does not provide a single-figure outcome for project acceptance.
