Chapter 13: Risk and Uncertainty in the short-term

Question 1

Is risk quantifiable or unquantifiable?

Answer 1

Quantifiable (outcomes have associated probabilities)

Question 2

Is uncertainty quantifiable or unquantifiable?

Answer 2

Unquantifiable (outcomes cannot be mathematically modelled)

Question 3

What is an expected value?

Answer 3

Summarises all the different possible outcomes by calculating a single weighted average. It is the long run average (mean)

Question 4

How do we calculate the EV (Expected Value)?

Answer 4

Σpx (p=probability of the outcome occurring, x=the future outcome)

Question 5

What do pay off tables show?

Answer 5

Profits that can be made from different possible outcomes. There are two factors to consider - demand and supply.
Table shows the different profits from each different contribution of demand and supply.
Probabilities are used on these different profit levels to calculate profits.

Question 6

What are the advantages of using expected values?

Answer 6

Takes risk into account
Easier decisions
Simple

Question 7

What are the disadvantages of using expected value?

Answer 7

Little meaning for a one-off project
Ignores attitudes to risk
The answer may not exist

Question 8

What does someone that is risk averse aim for?

Answer 8

Best possible outcome in the worst case scenario. Maximin.

Question 9

What does someone who is risk neutral ignore and aim for?

Answer 9

The range of outcomes and aim for the highest EV. Expected Value.

Question 10

What does someone who is a risk seeker aim for?

Answer 10

Best possible outcome in the best case scenario. Maximax.

Question 11

How do you calculate Maximin?

Answer 11

Determine the minimum payoff under each supply level.
Choose the supply level with the maximum of those values.

Question 12

How do you calculate maximax?

Answer 12

Determine the maximum payoff under each supply level.
Choose the supply level with the maximum of those values.

Question 13

What does a person who is risk averse and a sore loser aim for?

Answer 13

Aim to minimise the regret from making a bad decision. Minimax regret

Question 14

How do you calculate minimax regret?

Answer 14

Find maximum the payoff in each demand row.
Compare the actual payoff with ‘what we could have earned’
Create a regret table with the values in
Determine the maximum regret for each supply level
Choose the supply level which gives the minimum of those values

Question 15

How do we calculate standard deviation?

Answer 15

Compares all the actual outcomes with the expected value. It then calculates how far on average the outcomes deviate from the mean.

Question 16

If we have two project with very different EVs and it is not easy to compare their standard deviation what do we use?

Answer 16

Coefficient of variation

Question 17

How do we calculate coefficient of variation?

Answer 17

Standard deviation / mean (EV)

Question 18

What is the number give in normal distribution tables known as?

Answer 18

z score

Question 19

How do we calculate the z score?

Answer 19

(x - μ) / σ (x=value being considered, μ=mean, σ=standard deviation)

Question 20

Once we calculate the z score what table do we look it up on?

Answer 20

Normal distribution table

Question 21

What does decision trees force the decision make to consider?

Answer 21

Logical sequence of events.

Question 22

What does a decision tree do to solve complex problems?

Answer 22

Break them down into smaller, easier-to-handle sections

Question 23

What does the square represent in a decision tree?

Answer 23

A decision point

Question 24

What does the circle represent in a decision tree?

Answer 24

A chance point

Question 25

What is the value at the point of the square in a decision tree?

Answer 25

highest possible expected value from the options being considered

Question 26

What is the value at the point of the circle in a decision tree?

Answer 26

Expected value (based on the probabilities) of the outcome possible from this point forward