Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

CIMA P1 > D. Risk and uncertainty in the short term > Flashcards

D. Risk and uncertainty in the short term Flashcards

1
Q

What is the difference between risk and uncertainty?

A

risk

  • quantifiable
  • outcomes have probabilities so can apply maths

uncertainty

  • unquantifiable
  • outcomes cant be mathematically modelled as probabilities are unknown
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What is the expected value (EV)?

A

average result of all possible outcomes

-e.g if outcome is performed 1000 times

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

How is the expected value calculated?

A

sum of (p multiplied by x)

X=future outcomes
p=probability of the outcome occurring

weighted average of all possible outcomes

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

What is on the axis of a histogram?

A

outcomes vs probability

-each bar represents an outcome

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

What are the advantages of EV?

A
  • takes account of risk
  • easy decision rule: single number
  • simple to calculate
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What are the disadvantages of EV?

A
  • subjective
  • not useful for one-offs
  • ignores attitude to risk (assumed risk neutral)
  • answer may not be possible
  • ignores the spread of outcomes
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What does the EV NOT represent?

A
  • most likely outcome (one with highest probability)

- may not even represent a possible outcome

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What are the 3 types of decision makers?

A

risk seeker
risk neutral
risk averse

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What is a risk neutral decision maker?

A
  • consider all possible outcomes
  • select strategy that maximises the EV
  • focus on the EV
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What is a risk seeking decision maker?

A
  • select strategy with best possible outcome
  • regardless of likelihood
  • ignore EV
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What is a risk averse decision maker?

A
  • avoid risk

- select lower, but more certain outcome than higher payoff

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What is the basis of utility theory?

A

individual’s attitude to certain risk profiles will depend on the amount of money involved
-shows that basing options solely on EV ignores range of possibilities

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What is a pay-off table?

A

illustrates all possible profits/losses

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

What is the maximax rule?

A

select option that maximises the maximum pay-off

-for optimists/risk lovers

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What is the maximin rule?

A

option that maximises the minimum possible pay-off

-for pessimist/risk averse

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What is the minimax regret rule?

A

minimises maximum regret

  • i.e opportunity loss/ shortfall from maximum contribution
  • regret table:max demand at each choice then pick minimum
17
Q

What is perfect information?

A

forecast is correct

  • 100% accurate prediction
  • choose most beneficial action
18
Q

What is imperfect information?

A

not 100% correct

19
Q

How can value of information be caluclated?

A 
expected profit (outcome) WITH the info 
less expected profit (outcome) WITHOUT the info
20
Q

What is a decision tree?

A

diagrammatic representation of a decision problem, where all possible courses of action are represented and every possible outcome of each course of action is known

21
Q

What is a joint probability?

A

where outcome of one event depends on the outcome of a preceding event

22
Q

What do squares and circles represent in a decision tree?

A

square: represent a decision point i.e can choose a course of action
circle: change outcome point i.e subject to probabilities

23
Q

How are decision trees used in decision making?

A
  • calculate EV at each outcome point from right to left
  • choose best option at each decision point
  • recommend course of action to management
24
Q

What are the benefits of using a decision tree?

A
  • maps out clearly decisions in uncertainty
  • shows how interrelated events are
  • clearly annotates tree with probabilities, cash floes and EVs
25
Q

What other factors should be taken into account when considering decision tree-type problems?

A
  • assumes risk neutrality
  • sensitivity analysis:values are subjective
  • oversimplification:to make trees manageable, has to be simplified
  • suffers limitations of EV
26
Q

What is standard deviation?

A

compares actual outcomes to expected value

-measure of volatility:how far they deviate

27
Q

How does the standard deviation aid decision making?

A

higher SD means more risk and volatility

28
Q

What is the coefficient of variation?

A

measures the relative size of risk for projects that have varying SDs
-smaller coefficient=less dispersed and less risky

29
Q

How is the coefficient of variation calculated?

A
  • find SD:square of the deviations from the mean

- divide by mean or EV

30
Q

What is the peak of a normal distribution curve?

A

the mean

31
Q

How is data split in the bell shaped curve?

A

50% to the right, 50% to the left

32
Q

What are the characteristics of a normal distribution curve?

A
  • continuous probability distribution
  • probabilities are represented by areas under the curve
  • total area under curve=1
  • curve is symmetrical and bell shaped
  • width of the curve is measured in terms of SD
  • mean, median and mode are at the centre of the curve
33
Q

What is the z score?

A

allows us to calculate the proportion of the distribution meeting certain criteria for any normal distribution
-i.e we can determine probabilities

34
Q

How is z score calculated?

A

difference/SD

-deduct z score from 0.5

35
Q

What is sensitivity analysis in decision making?

A
  • takes each uncertain factor in turn
  • calculates the change that would be necessary in that factor before the original decision is reversed
  • established which estimates are more critical
36
Q

What is the sensitivity analysis process?

A
  • best ESTIMATES made and a decision arrived
  • each variable analysed in turn to see EFFECTS of change on estimate
  • estimates for each variable can then be reconsidered to assess the LIKELIHOOD of the decision being wrong
37
Q

What are the strengths of sensitivity analysis?

A
  • info presented to mgmt in a form which facilitates subjective judgement to decide the likelihood of the various possible outcomes considered
  • identifies area which are crucial to the success of the project so they can be monitored
38
Q

What are the weaknesses of sensitivity anlaysis?

A
  • assumed that changes to variables can be made independently. Can simulate to make more than one change
  • only identifies how far a variable needs to change; does not look at the probability of such a change
  • provides information on the basis of which decisions can be made but it does not point to the correct decision directly

CIMA P1 (4 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions