Risk in Business and Society Surviva+ Guide Exam 1 Page | 1 Survival Guide Risk in Business and Society Exam 1 Study Guide1 *Note: Definitions and important ideas are bolded. - Topic 1: Basics of Risk o What is risk? Uncertainty regarding loss Examples of risk - Jumping off a 1 story building is more risky than jumping off a 25 story building risk is not the same as danger o Terminology Frequency: likelihood, how often Severity: when it does occur, how bad is the damage? Expected Value: loss, not always possible, just a measure Degree of Risk: relative variation of actual from expected loss (variation or standard deviation) Uncertainty: doubt about ability to predict future outcomes Exposure: person or property facing the risk of loss Peril: the immediate cause of loss Hazard: condition affecting the frequency or severity of loss - Physical: property conditions - Intangible: attitudes or culture o Moral (Morale): behavioral, indifference o Societal: legal or cultural o Categories of Risk Pure vs. Speculative Static vs. Dynamic Fundamental vs. Particular Core vs. Secondary Definitions - Pure: simply loss or no loss - Speculative: loss, no loss or gain - Static: stays the same over time - Dynamic: changes over time - Fundamental: affect a large portion of the population at the same time - Particular: affects a very small portion of the population - Core: a risk assumed with business - Secondary: a risk as a side effect of business o Sources of Risk Personal: health 1 Use of this Survival Guide is subject to the Terms and Conditions found at www.survivalguidefsu.yolasite.comRisk in Business and Society Surviva+ Guide Exam 1 Page | 2 Property: cars, clothing, building Liability: held responsible for actions Financial: investments o Attitudes Toward Risk Risk Neutral: indifference towards risk Risk Averse: prefer to avoid risk Risk Seeker: prefer risk o Risk Management (RM) The scientific view of risk Rules of RM - Do not risk more than you can lose - Do not risk a lot for a little - Consider the odds o The RM Process Determination of the objectives (of the firm) - Pre-Loss vs. Post-Loss objectives Identification of Risk - Use of risk identifiers (ex: questionnaires, procedure guides, inspection) - the best approach uses many tools Evaluation of Risk - Loss Frequency (Probability Distributions) - Loss Severity o Maximum Possible Loss o Probable Maximum Loss - Use of Statistics o Central tendency o Measures of variation (where the risk lies, uncertainty) o Variance= {loss value-E(loss)}2*P(loss) o Standard Deviation= Sqrt of Variance o Coefficient of Variance= Standard Deviation/E(loss) Consideration of the alternatives - Loss Control, Loss Financing or Internal Risk Reduction Implementation of decision Evaluation and review o Scientific View of Risk Different View of Risk in Public Policy - Probability of a person suffering an adverse effect from an activity or exposure over a given period of time - Topic 2: Risk and the Entrepreneurial Spirit Risk in innovation depends on the choices individuals make Innovation makes us feel safer and in doing so, we become more likely to take risky actions o 5 Rules of Thumb to Minimize Risk Recognize you need a model - Mental model: may be oversimplifiedRisk in Business and Society Surviva+ Guide Exam 1 Page | 3 - Mathematical Model: allows more precision o The more facts, the better the outcome of the model Acknowledge Your Model’s Limitations - All models are wrong: can either be incorrect or incomplete o Incorrect: a model whose internal logic or underlying assumptions are themselves wrong o Incomplete: all models, does not need to be stopped but rather added to Expect the unexpected - Some factors will be overlooked - The recent financial crisis overlooked 3 factors o Efficient mortgage refinancing market o Low interest rates o Rising home prices - What happens when models fail? o Twitter hacked on April 23rd 2013 (the Associated Press account) Tweets about White House bombings released Market dropped significantly (DOW JONES lost 140 pts.) Understand the use and the user - Triplet: model, application, user Infrastructure - Consequences of infrastructure - Changes in infrastructure usually lag changes in products and services, leads to a major source of risk - Topic 3: Organizational Decision Making, Decision Theory o Decision Theory: used to determine optimal strength where a decision-maker is faced with several alternatives in uncertainty o Steps of Decision Making Identify possible outcomes Identify sources of action Determination of the pay-off function Choosing from among various alternatives on the basis of some criterion o One Step Decision Making Process Identify source of action Pay-off and regret tables Choose a course of action with some principle o Pay-Off Table: represents the matrix of conditional values associated with all the possible combinations of the acts and events o Opportunity Loss or Regret: the amount of profit forgone by not adopting the optimal course of action o Requirements to use the Pay-Off Matrix Must be a single decision, not sequential Courses of action must be clearly determined Actions must be distinctRisk in Business and Society Surviva+ Guide Exam 1 Page | 4 o Decision Rules Under Uncertainty Laplace Principle - If outcome is unknown, treat all events as equally probably, then choose the action which yields the greatest value Maximin or Minimax Principle - the principle adopted by conservatives - you find the minimum payoff for each action, then choose the highest of that Maximax or Minimin Principle - Choose the action with the highest maximum payoff If Probabilities ARE PRESENT: - Maximum Likelihood Principle o Choose the action most likely to occur and choose the highest valued in that column - Expectation Principle o After probabilities, sum to find payout o The more information we have, the better o Multistage Decision Making Process Evaluate backwards, choose best decisions in later steps to choose best decisions in early steps o Expected Value EV(x)=P1x1+P2x2+…. (P=probability, x=outcomes) Good luck on your exam!
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