Weeks 5& 6 - Weeks 5 6 Lecture 7 Risk(Uncertainty and...

This preview shows page 1 - 2 out of 5 pages.

Weeks 5 & 6 Lecture 7: Risk (Uncertainty) and Return Risk preferences: 1. Risk taker: will always take the riskier investment even with the same return 2. Risk indifferent: doesn’t care about risk if the return is equal 3. Risk adverse: will take the smallest amount of risk given the same return How can you measure risk? 1) Probability Distributions – calculate the expected value (return) and standard deviation. Ex.) Builtrite is considering the following two mutually exclusive projects: (one or the other, not both) Project A: Belief Cash Flow Prob Weighted Average Pessimistic 40 x .20 = 8 Most likely 45 .60 27 Optimistic 50 .20 10 Expected return = 45 Project B: Belief Cash Flow Prob Weighted Average Pessimistic 0 x .20 = 0 Most likely 45 .60 27 Optimistic 110 .20 22 Expected return = 49 Which project should be picked? Which project has less risk? Project A has less risk Which project has more variability (risk)? Project B is riskier We measure variability by the standard deviation “ σ “ Standard deviation A = sqrt( ((40-45)squared*.20)+((45-45)squared*.6)+((50-45)squared*.20))= 3.16
Image of page 1

Subscribe to view the full document.

Diversification and risk - Total risk = diversifiable risk + nondiversifiable risk “company specific” + “market risk” “unsystematic risk” + “systematic risk” Lawsuits war Strikes inflation - By diversifying, we can reduce “company specific” risk, but not market risk.
Image of page 2
You've reached the end of this preview.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern