RMI 2302 NYCE EXAM 2
Risk/ Reward - Answer- - Individuals
- Organizations
- Gov't/ Society
Individuals (risk/ reward) - Answer- - Measured using expected utility
- How much reward is necessary to induce you to take risk?
- Similarly, how much are you willing to pay to avoid risk? ...
Individuals (risk/ reward) - Answer- - Measured using expected utility
- How much reward is necessary to induce you to take risk?
- Similarly, how much are you willing to pay to avoid risk? This is actually the entire basis of insurance,
people willing to pay to avoid risk
Ex) - $5 wealth
- 50/50 chance of ending up with $1 or $9 dollars
- utility function is the sq. root function
- how much reward is necessary to get the individual to take the risk?
organizations (risk/ reward) - Answer- - organizations use expected value, not expected utility
- NO natural risk aversion
- opportunity cost or cost of capital
- most organizations project future cash flows from investments/ opportunities
- discount those cash flows back to present value based on cost of capital
- cost of capital is commensurate with riskiness of firm
Gov't/Society (risk/ reward) - Answer- - Measuring reward to society is difficult (reward of national
parks)
- many times government is the only entity able to take on risk, regardless of reward
Bias - Answer- - Subjective view/probability - different from objective
,- many sources
- alter the decision making
- problem when it ends up being significantly different from the model
Types of Bias - Answer- - Age bias
- Cultural biases
- Experience biases
- Gender biases
- Media biases
Incentives - Answer- - How to get people to make decisions that are advantageous to us.
- Incentives motivate individuals to perform an action.
- Incentives can be at the individual level, organizational level, or societal level.
- Generally, we refer to incentive structures
- Economics = study of incentive systems
- Beware: "law of unintended consequences"
- Political incentives
(short term vs. long term planning)
(discount rate)
Types of incentives - Answer- - Financial: Most incentives
- moral: "do the right thing"
- natural: curiosity, fear, anger, pain, joy, pursuit of happiness
- Coercive: negative reinforcement
- Personal vs. Social
Ways (categories) of looking at risk at the individual level - Answer- - property
- liability
, - life
- health
- financial
- why categorize?
(risk management techniques)
(categories may not be mutually exclusive (some risks may appear in multiple categories))
Loss exposures - Answer- Any condition or situation that presents a possibility of loss, regardless of
whether that loss actually occurs
Three elements to a loss exposure - Answer- - asset exposed to loss
- cause of loss
- financial consequences of the loss
Property (loss exposure) - Answer- Asset exposed to loss
- real property: land buildings, crops, etc...
- personal property: your stuff: furniture, jewelry, art, autos, watercraft, etc....
Cause of loss
- fire, theft, windstorm, accidents, lost, pretty much anything you can think of
Financial consequences of the loss
- reduction in property value
- increase expenses
- lost income
liability (loss exposure) - Answer- Asset exposed to loss
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