Part 1 - Risk and Uncertainty Flashcards
What is RISK?
Risk relates to the variability of outcomes , the probabilities of which are KNOWN, or can be ESTIMATED
What is UNCERTAINTY?
Uncertainty occurs where the outcomes and their probabilities are UNKNOWN
What is EXOGENOUS VARIABLES?
Are variables that are determined externally, for example, the cost of a raw material imposed by the supplier
What is risk appetite?
The amount of risk an organisation is WILLING TO TAKE on or is prepared to ACCEPT in pursuing its strategic objectives.
What is a risk seeker?
A decision maker who is interested in trying to secure the BEST OUTCOMES, no matter how small the chance that they may occur.
What is risk-neutral?
If they are concerned with what will be the MOST LIKELY outcome
What is a risk-averse decision maker?
A risk-averse decision maker acts on the assumption that the WORST outcome might occur
What is the ‘play it safe’ basis – MAXIMIN basis? – Decision rule
+ The ‘play it safe’ basis for decision making is referred to as the maximin basis. This is short for ‘maximise the minimum achievable profit’
+ Useful for risk-averse
What is MAXIMAX? – Decision rule
+ A basis for making decisions by looking for the best outcome is known as the maximax basis, short for ‘maximise the maximum achievable profit’.
+ Useful for risk seeker
What is ‘opportunity loss – MINIMAX REGRET? – Decision rule
The ‘opportunity loss’ basis for decision making is known as minimax regret. The minimax regret strategy is the one that minimises the maximum regret. It is useful for a risk-neutral decision maker
Mẫu câu xác định lựa chọn dựa vào risk appetite
+ Employees are cautious about the proposal to export to Kayland, and are risk averse. They would use the maximin rule, which is the choice of product with the best of the lowest outcomes. In this case, this is Blue
+ Shareholders are risk neutral. They will choose the product with the highest expected value; in this case this is also Blue
Disadvantages of Maximin
+ Can be an excessively risk averse approach
+ Some commercial risks will have to be taken
+ Ignore the probability of the outcome actually occurring
Disadvantages of Maximax
+ May be overly optimistic
+ That directors take risks which exceed the shareholders’ risk appetite so as to earn high bonuses
+ Ignore the probability of the outcome actually occurring
Disadvantages of Expected Value
+ The expected value approach is a long run average which can be applied to decisions which are repeated many times
+ The actual expected value is not a possible outcome and will never occur in practice
+ The expected value approach relies on estimates of probabilities. These may be subjective or difficult to make, which limits the value of this approach
The importance of incorporate risk and uncertainties in long-term decision
+ Shareholders take into account prospective returns and the level of risk involved
+ Long-term strategic planning requires forecasts to made about future events. These future events are by definition unknown, and subject to risk and uncertainty
+ The further into the future the plans project, the riskier, and more uncertain, events are likely to be, as it is harder to predict what conditions will be.
