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Risk analysis
- 2. In the managerial decision making, managers do not know the exact outcome of each possible course of action. Indra Prasad Pyakurel
- 3. Profit Depends on Degree of Future competition Consumer’s taste Technological advancement Political climate Others Indra Prasad Pyakurel Imperfect knowledge about determinants of profit creates the problem of risk or uncertainty.
- 4. Managerial decisions are made under the various conditions: CERTAINTY, RISK OR UNCERTAINTY Indra Prasad Pyakurel Certainty Only one outcome to decision
- 5. Risk or Uncertainty More than one outcomes to decision Indra Prasad Pyakurel
- 6. Risk is defined as the chance of loss. More risky implies more probability of loss and vice-versa. “Risk refers to a situation in which there is more than one outcome to a decision and the possibilities of each specific outcome is known or can be estimated.” DOMINICK SALVATORE For Example: Toss of coin, Investment on Stock , Introducing New product etc. Indra Prasad Pyakurel
- 7. Uncertainty is a situation when outcome of managerial decisions cannot be predicted with absolute accuracy. “Uncertainty is the case when there is more than one possible outcome to a decision and where the possibilities of each specific outcome occurring is not known.” DOMINICK SALVATORE For example: drilling for oil Indra Prasad Pyakurel
- 8. General Risks 1. Business Risk 2. Market Risk 3. Inflation Risk 4. Interest Risk 5. Credit Risk 6. Liquidity Risk Special Risk 1. Cultural Risk 2. Currency Risk 3. Government policy Risk 4. Expropriation Risk Indra Prasad Pyakurel
- 9. Higher risk implies higher returns It means, taking higher risk causes a greater expected return. More money means more satisfaction, Mathematically, U = f(M) Where, U= Utility of an individual M= Money Indra Prasad Pyakurel
- 10. 1. Risk Averter/Avoider:- Diminishing marginal Utility of money Upward sloping concave nature utility curve Second order derivative will be negative A person is said to be risk averter if the increase in utility as money increases is less than the decrease in utility as money decreases. Indra Prasad Pyakurel
- 11. 2. Risk Lover/ Risk Seeker Increasing marginal Utility of money Upward sloping convex nature utility curve Second order derivative will be positive A person is said to be risk lover if the increase in utility as money increases is greater than the decrease in utility as money decreases. Indra Prasad Pyakurel
- 12. 3. Risk Neutral Constant marginal Utility of money Upward sloping straight line Second order derivative will be zero A person is said to be risk lover if the increase in utility as money increases is equal to the decrease in utility as money decreases. Indra Prasad Pyakurel
- 13. Indra Prasad Pyakurel U1 U2 U3 U4 o Y1 Y2 E A B C Money Income Utility Of Money M N P
- 18. Perfect Competitive Market Indra Prasad Pyakurel Perfect Knowledge about market Complete information avoids the Uncertainties underling in economic transaction
- 19. Indra Prasad Pyakurel Imperfect Competitive Market Incomplete or Asymmetric Information Incomplete information creates the Uncertainties or risk underling in economic transaction
- 20. Asymmetric information, also known as information failure, occurs when one party to an economic transaction possesses greater material knowledge than the other party. This normally manifests when the seller of a good or service has greater knowledge than the buyer, although the reverse is possible. Almost all economic transactions involve information asymmetries. Indra Prasad Pyakurel
- 21. A good example is when selling a car, the owner is likely to have full knowledge about its service history and likelihood to break- down. The potential buyer, by contrast, will be in the dark and he may not be able to trust the car salesman. Asymmetric information can lead to adverse selection, incomplete markets and is a type of market failure. Indra Prasad Pyakurel
- 23. 1. Adverse Selection 2. Signaling 3. Moral Hazard Indra Prasad Pyakurel