Week 4

Question 1

Ways companies always mismanage risk (6)

Answer 1

1. Relying on historical data
2. Focusing on narrow measures
3. Overlooking knowable risks
4. Overlooking concealed risks
5. Failing to communicate
6. Not managing in real time

Question 2

Ways to overlook knowable risks

Answer 2

• risks outside the normal risk class
• risks incurred by hedging
• market concentration risks
• value assumption risks

Question 3

You understand your causal model and can predict the outcome of your decision with reasonable certainty

Answer 3

Conventional capital-budgeting tools

Question 4

You understand your causal model and can predict a range of possible outcomes

Answer 4

Quantitive multiple scenario tools

Question 5

You don’t understand your causal model, but you can predict a range of outcomes

Answer 5

Case-based decision analysis

Question 6

You don’t understand your causal model and you can’t predict a range of outcomes

Answer 6

Case-based decision analysis

Question 7

You understand your causal model but cannot predict outcomes

Answer 7

Qualitative scenario analysis supplemented with case-based decision analysis

Question 8

Causal model

Answer 8

Strong understanding of what critical success factors and economic conditions, in what combination, will lead to a successful outcome

Question 9

Conventional capital-budgeting tools

Answer 9

Use cashflows to make decisions (discounted cash flow, expected rate of return, NPV models)

Question 10

Quantitative multiple scenario tools

Answer 10

Specify possible outcomes and their probability (Monte Carlo, decision analysis, real options)

Question 11

Qualitative scenario analysis tools

Answer 11

Develop a set of qualitative scenarios of how the present may evolve into the future and identifies the consequences

Question 12

Case-based decision analysis

Answer 12

Provides an approach to aggregating and synthesizing information from past experiences and examples

Question 13

Limitations to use of information markets (2)

Answer 13

• Information and prediction makets can only be used when executives are able to specify a range of possible outcomes
• Information may leak out

Question 14

Alternatives to information markets (2)

Answer 14

• Incentives estimates

- Similarity-based forecasting

Question 15

Risk

Answer 15

Known probability distribution for the event

Question 16

Ambiguity

Answer 16

Not clear what events and probabilities are relevant

Question 17

Utility

Answer 17

Weighted average of the utility in each possible state

Question 18

Assumptions of game theory (4)

Answer 18

• All actors behave rationally & try to win
• All actors are interdependent
• All actors are aware of their interdependence
• All actors know all moves that are possible

Question 19

Dominant strategy

Answer 19

• Outperforms all other strategies regardless of rival’s actions
• Might nog be highest possible pay-off, but you always win

Question 20

Dominated strategy

Answer 20

Always lose regardless of what the actor does

Question 21

Equilibrium

Answer 21

Each actor gets best possible payoff given the rivals’ responses

Question 22

Tit for that

Answer 22

• Always start with cooperation
• If rival attacks, you counterattack, then try cooperation again
• Responses should be proportional

Question 23

Conditions that hinder cooperation (3)

Answer 23

• Large number of competitors
• Substantial differences between actors
• Lack of transparency