This document defines probability and risk concepts. It explains that probability expresses the likelihood of an event occurring on a scale of 0 to 1, where 0 is impossible and 1 is certain. There are different types of probabilities like exact, empirical, and subjective probabilities based on data or judgment. Empirical probabilities can be estimated through primary market research generating new data or secondary research reviewing existing findings. Expected value is defined as a technique to judge financial outcomes, calculated as the weighted average of possible outcomes multiplied by their probabilities. Probability trees use branches and nodes to visually represent probabilities and expected values of outcomes.

1. RISK - PROBABILITY

2. Definitions
• A probability expresses the likelihood of an event occurring.
• Basic ideas:
• If an event is certain to occur, then it has a probability of one.
• If an event is impossible, then it has a probability of zero.
• For any event, the probability of it occurring must lie between zero and one. If
you calculate a probability bigger than one, then you have made a mistake!
• The higher the probability is, then the more likely it is that the event will
happen.
• In any given scenario, the probabilities associated with all possible outcomes
must add up to one.

3. Simple Probabilities

4. Types of probabilities
• There are different types of probabilities. Probabilities can be:
• Exact. These can be applied to the population of outcomes,
e.g. the probability of a certain card being drawn from a pack of
cards
• Empirical. These can be calculated from samples of
observations from the past, e.g. the probability of a certain level
of sales occurring in a day
• Subjective. These are based on judgement, e.g. the probability
of winning a new order, or finding oil in a new drilling area

5. Estimating Empirical Probabilities
• Company wish to condust Market research to obtain data to
allow empirical probability to be estimated.
• Market research may involve either:
• Primary research, which generates new, primary data, such
as through the trial above. This also known as field research.
• Secondary research, where existing research findings are
reviewed. This is also known as desk research and the data
referred to as secondary data.

6. Expected Values
• One technique which can help judge the financial outcomes of
various options is expected value (EV).
• An expected value is a long run average. It is the weighted average of
a probability distribution.
• Expected value is calculated as follows:
X=Outcome; P= Probability of Outcome

7. Probability trees
• They use lines called branches
• Squares depict decision points
• Circles depict chance outcome points
• The probabilities of the outcomes are shown on the branches.
(Remember, probabilities should add up to 1)
• The financial outcomes are shown at the end of the branches, and the
expected values are calculated by working back, right to left, along
the branches.