Choice of loss due the fact that all possible outcomes and their probability of occurrence are unknown.
Types Of
Risks:
Economic
risk: Choice of loss due the fact that
all possible outcomes and their
probability of occurrence are unknown.
Uncertainty:
When the outcomes of managerial decisions cannot be predicted with absolute accuracy but
all possibilities and their associated probabilities of occurrence are known.
Business risk: Chance of
loss associated with a given managerial decision.
Market
risk: Chance that a portfolio of
investments can lose money due to volatility
in the financial market.
Inflation
risk: A general increase in the price
level will undermine the real economic
value of any legal agreement that involves a fixed promise to pay over an
extended period.
Interest
rate risk: The changing interest rates
affect the value of any agreement
that involves a fixed promise to pay over a specified period.
Credit
risk: May arise when the other party
fails to abide by the contractual obligations.
Liquidity risk: Difficulty
of selling corporate assets and investments.
Derivative
risk: Chance that volatile financial
derivatives could create losses on
investments by increasing price volatility.
Cultural
risk: Risk may arise due to loss of
markets differences due to distinctive
social customs. Currency
risk: Is the probable loss due to
changes in the domestic currency value
in terms of expected foreign currency. Government
policy risk: Chance of loss because of
domestic and foreign government
policies. The above listed various types of
risks are involved in business. Therefore it is essential for the manager to
understand the type of risk and strategies to overcome the same. The manager
must know the possible outcomes of a particular event, action or decision.The
manager must be aware of the probability of risks in business. (Probability
means likelihood that a given outcome will occur) For example; a purchase of share
may lead to three probable results i.e. either the price will increase,
decrease or it can be the same. Objective interpretation relies on the
frequency with which certain events tend to occur. Out of 100 shares, if 25
have increased and 75 have remained in the same level in the market then the
probability of incurring profit is ¼. If there is no past experience then we go
for subjective probability and based on our perception of occurrence we may
measure the probability. But manager’s perceptions differ therefore they make
different choices. In general probabilities are measured in two ways they are
expected value and variability. Expected value: The
probable payoffs associated with all possible outcomes are called as expected value.
Variability:
The extent to which the possible outcomes of an uncertain situation differ. This difference is
called as deviation; it means difference between expected outcome and the
actual outcome.
Manager’s attitudes toward risk
affect the decision making. The preference towards risk is classified as, risk
loving, risk aversion and risk neutral.
Risk loving: Arises
when the payoff is greater than the expected value.
Risk
Aversion: Is the behavior of the mangers when the pay off is
less than the expected value.
Risk
neutral: Behavior takes place when the expected value is equal
to the payoff.
Tags : Managerial Economics - Analysis Of Risk And Uncertainty
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