RMI 2302 Exam 2 Study Guide Module 6 Risk Reward Make sure you understand this relationship Employers want employees who can make critical decisions Individuals o Measure using expected utility o How much reward is necessary to induce you to take risk o Similarly how much are you willing to pay to avoid risk This is the entire basis of insurance people willing to pay to avoid risk Organizations o Use expected value not expected utility o No natural risk aversion o Opportunity cost or cost of capital o Most organizations project future cash flows from investments opportunities capital o Cost of capital is common with riskiness of firm o CAPM Only reward systemic risk Not diversifiable risk o Discount those cash flows back to present value based on cost of o Measuring reward to society is difficult o Many times the government is the only entity able to take on risk o Subjective view probability different from objective o Many sources o Alter the decision making o Problem when it ends up being significantly different from the model o Efficient frontier Governments society regardless of reward Bias What is bias Donald Rumsfeld o unknown unknowns Types of bias Age biases Cultural biases Experience biases Gender biases Media Biases Incentives How do we get people to make decisions that are advantageous to us o Incentives Things that motivate individuals to perform an action o Incentives can be at the individual level organizational level or societal level o Incentive structures Study of economics is basically a study of incentive systems Beware The law of unintended consequences Political incentives o Short term vs long term planning o Discount rate Types of incentives Financial most incentives Moral Do the right thing Natural Curiosity fear anger pain joy pursuit of happiness Coercive Negative reinforcement Personal vs social Lots of ways categories of looking at risk at the individual level Module 7 Overview of risk for individuals o Property o Liability Risk Management for individuals Loss exposures o Any condition or situation Property Asset exposed to loss o Real property Cause of loss think of Financial consequences o Reduction in property value o Increased expenses o Lost income Liability Asset exposed to loss Land buildings crops etc o Personal property Your stuff furniture jewelry art automobiles etc o Fire theft windstorm accidents lost pretty much anything you can o Money other financial assets o General special hard to figure out loss of limb punitive damages punishment make sure they don t do it again Cause of loss o Claim lawsuit o Civil law vs criminal law o Tort contract statuary o Negligence Automatically at faulty violating speed limit Financial consequences o Defense costs o Monetary damages Specific types of liability Property owners Automobiles Employer employee Parents and children Animals Life premature death Asset exposed to loss o Your life Cause of loss Financial consequences Financial impact of premature death Wage earning adult o Married adult o Single with dependents o Single with no dependents Non wage earning adult o Married o Single with dependents o Single with no dependents Child Life long life o Premature death illness accident stupidity Asset exposed to loss o Your saving retirement wealth Cause of loss o Outliving assets expenses income for too long Financial consequences o What happens when retired o Income o Expenses Which increase Which decrease Health Disability Asset exposed to loss o Your health livelihood Cause of loss o Poor care poor genes bad luck injury illness etc Financial consequences o Ability to earn income may decrease or cease as in premature death o Living expenses may continue or increase o Evaluate same exposure categories as premature death o Health disability unemployment poor planning etc Financial Asset exposed to loss o Your wealth Cause of loss Financial consequences o Inadequate savings o Back to work o Can t retire How do you apply it How do you evaluate o Frequency severity Wealth Income What are smart pills Death only happens once but probability does vary o Severity does vary based on Stimulant drugs such as Ritalin and Adderall have been developed to help manage ADHD Classified as schedule II drugs by the DEA same classification as cocaine o Illegal to take without a prescription federal offense Have proven successful in managing ADHD What is the risk Insomnia weight loss decreased appetite jitteriness Increased risk of cardiovascular problems Exacerbate depression psychosis anxiety o 1 in 400 in doctor managed patients Potentially addictive Decreased performance over time due to insomnia addiction malnutrition Paranoia aggression irritability What is the reward Improved performance on learning tasks such as memorization especially for longer term memory more than one day since education now seems to be a competitive sport Need to be on drug while studying not while taking the exam Who is using it You are o Prescription use doubled from 2007 to 2011 o Studies estimate 25 35 of college students have used Ritalin Adderall off prescription o 3 4 of pop are ADHD skewed toward younger children many out grow it o Users are also more likely to Smoke pot Skip class The reading Yes Yes they are dangerous o Alan Schwarz o Case on Richard Fee Points out problems in health care system o Quick diagnosis o Ability to manipulate feign symptoms o Quick to medicate o Doctor shopping o Not sure how all pharmaceuticals interact The reading No Joshua Gowin No different than other stimulants e g caffeine Just more sophisticated They work so use them Take aways What is the risk reward trade off Are the benefits real Are the risks real Is it cheating Is it ethical Module 8 Overview of risk for corporations Lots of ways categories of looking at risk at the organizational level o Business risk operational risk hazard risk financial risk strategic risk Why categorize Business risk o Expertize risk management techniques reports to stakeholders o Categories not mutually exclusive o Deviations in profitability o Can be cause by many things prices regulation competition etc o Very broad category many will define as risk caused by operation hazard financial or strategic risks Operational risk o Potential losses from internal sources Manufacturing processes Fraud Mismanagement Employee mistakes o Very traditional risk management stuff o Typically used in the insurance industry o Potential variation due to financial causes o Losses due to exchange
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