7 Risk and uncertainty

Question 1

What is risk?

Answer 1

There are a number of possible outcomes and the probability of each is known

Question 2

What is uncertainty?

Answer 2

There are a number of possibly outcomes and the probability of each is unknown

Question 3

What are focus groups?

Answer 3

A common market research tool invoking small groups selected from the broader population.

Question 4

What are the problems with focus groups?

Answer 4

• results are qualitative
• the sample size may mean that results are not a good representative
• individuals may feel pressure to agree with other members
• their cost and complexity is cited as a barrier, especially for smaller companies.

Question 5

What is desk research?

Answer 5

Information is collected from secondary sources, it obtains existing data by studying published and other available sources of information. Usually eliminates the need for extensive field work

Question 6

What factors should be considered when using desk research?

Answer 6

It may not be exactly what the researcher needs or up to date
It is cheaper and quicker than field research

Question 7

What is market intelligence?

Answer 7

Information about a companies present or possible future markets

Question 8

What is economic intelligence?

Answer 8

Defined as information relating to the economic environment within a company operates.

Question 9

What is field research?

Answer 9

Information is collected from primary sources by direct contact with a target group, it is expensive but accurate and up to date.

Question 10

What are the two types of field research?

Answer 10

Motivational research and measurement research

Question 11

What is motivational research?

Answer 11

The objective is to understand factors that influence why consumers do or do not products

Question 12

What are some types of ways to complete motivational research?

Answer 12

Depth interviewing
Group interviewing
Word association testing
Triad testing

Question 13

What is depth interviewing?

Answer 13

Undertaken at a length by a trained person who is able to appreciate conscious and unconscious associations and motivations and their significance

Question 14

What is group interviewing?

Answer 14

Where between six and people are asked to consider the subject under trained supervision

Question 15

What is word association testing?

Answer 15

On being given a word by the interviewer, the first word that comes to mind of the person tested is noted

Question 16

What is triad testing?

Answer 16

Where people are asked which out a given three items they prefer

Question 17

What is measurement research?

Answer 17

The objective here is to build on the motivational research by trying to quantify the issues involved

Question 18

What is random sampling?

Answer 18

Where each person in the target population has an equal chance of being selected. (May be unfeasible in practice)

Question 19

What is quota sampling?

Answer 19

Where samples are designed to be representative with respect to pre selected criteria

Question 20

What is panelling?

Answer 20

Where the sample is kept for subsequent investigations so trends are easier to spot

Question 21

What is observation?

Answer 21

Though the use of cameras within supermarkets to examining how long customers spend looking at a product

Question 22

What are some common methods of measurement research?

Answer 22

Random sampling
Quota sampling
Panelling
Surveying by post
Observation

Question 23

What is sensitivity analysis?

Answer 23

Takes each uncertain factor in turn and calculates the chain that would be necessary in that factor before the original decision is reversed

Question 24

What is the process for sensitivity analysis?

Answer 24

1 best estimates for variables are made and decision arrived at.
2 Each of the variables is analysed in turn to see how much the estimate can change before the original decision can be reversed.
3 Estimates for each variable can then be reconsidered to assess the
likelihood of the estimate being wrong
4. The maximum possible change is often expressed as a percentage.
This formula only works for total cash flows

Question 25

What are the strengths of sensitivity analysis? (3)

Answer 25

- There is no complicated theory to understand. - Information will be presented to management in a form which facilitates subjective judgement to decide the likelihood of the various possible outcomes considered. - It identifies areas which are crucial to the success of the project. If the project is chosen, those areas can be carefully monitored.

Question 26

What are the weaknesses of sensitivity analysis? (3)

Answer 26

- It assumes that changes to variables can be made independently, . - It only identifies how far a variable needs to change; it does not look at the probability of such a change. - It provides information on the basis of which decisions can be made but it does not point to the correct decision directly.

Question 27

What is simulation?

Answer 27

A modelling technique that shows the effect of more than one variable changing at the same time.

Question 28

When is simulation often used?

Answer 28

Capital investment appraisal.

Question 29

What is the Monte Carlo simulation method?

Answer 29

Uses random numbers and probability statistics. It can include all random events that might affect the success or failure of a proposed project.

Question 30

What are the drawbacks of simulation? (4)

Answer 30

- It is not a technique for making a decision, only for obtaining more information about the possible outcomes. - Models can become extremely complex. - The time and costs involved in their construction can be more than is gained from the improved decisions. - Probability distributions may be difficult to formulate.

Question 31

What is expected values?

Answer 31

An expected value is a weighted average of all possible outcomes. It calculates the average return that will be made if a decision is repeated again and again.

Question 32

What is the formula for expected value?

Answer 32

The formula for the expected value is | EV = Σpx

Question 33

What is expected values useful for?

Answer 33

It is a useful decision rule for a risk neutral decision maker

Question 34

What are the advantages of expected values? (3)

Answer 34

- Takes uncertainty into account by considering the probability of each possible outcome and using this information to calculate an expected value. - The information is reduced to a single number resulting in easier decisions. - Calculations are relatively simple.

Question 35

What are the disadvantages of expected values? (3)

Answer 35

-The probabilities used are usually very subjective. -The EV is merely a weighted average and therefore has little meaning for a one off project. -The EV gives no indication of the dispersion of possible outcomes about the EV, i.e. the risk. -The EV may not correspond to any of the actual possible outcomes.

Question 36

Why is a pay off table useful?

Answer 36

It is a useful way to represent and analyse a scenario where there is a range of possible outcomes and a variety of possible responses.

Question 37

What does a pay off table illustrate?

Answer 37

A pay off table simply illustrates all possible profits/losses.

Question 38

What is maximax?

Answer 38

The maximax rule involves selecting the alternative that maximises the maximum pay off achievable.

Question 39

Who is maximax aimed for?

Answer 39

Suitable for an optimist, or 'risk seeking' investor, who seeks to achieve the best results if the best happens

Question 40

What is maximin?

Answer 40

The maximin rule involves selecting the alternative that maximises the minimum pay off achievable.

Question 41

Who is maximin aimed for?

Answer 41

This approach would be appropriate for a risk averse pessimist who seeks to achieve the best results if the worst happens.

Question 42

What is the minimax regret rule?

Answer 42

The minimax regret strategy is the one that minimises the maximum regret

Question 43

Who is the minimax regret rule useful for?

Answer 43

It is useful for a risk | averse decision maker. Essentially, this is the technique for a sore loser who does not wish to make the wrong decision.

Question 44

What is a decision tree?

Answer 44

A decision tree is a diagrammatic representation of a multi decision problem, where all possible courses of action are represented, and every possible outcome of each course of action is shown.

Question 45

When should decision trees be used?

Answer 45

Decision trees should be used where a problem involves a series of decisions being made and several outcomes arise during the decision making process

Question 46

What does a decision tree force the decision maker to do?

Answer 46

Consider the logical sequence of events

Question 47

What is perfect information?

Answer 47

The forecast of the future outcome is always a correct prediction. If a firm can obtain a 100% accurate prediction they will always be able to undertake the most beneficial course of action for that prediction.

Question 48

What is imperfect information?

Answer 48

The forecast is usually correct, but can be incorrect. Imperfect information is not as valuable as perfect information.

Question 49

How is the value of information calculated?

Answer 49

Expected profit (outcome) WITH the information LESS Expected profit (outcome) WITHOUT the information