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Unformatted text preview: Chapter 16 RISK ANALYSIS QUESTIONS AND ANSWERS Q16.1 In economic terms, what is the difference between risk and uncertainty? Q16.1 ANSWER Economic risk is the chance of loss because all possible outcomes and their probability of happening are unknown. Actions taken in such a decision environment are purely speculative, such as the buy and sell decisions made by traders and other speculators in commodity, futures, and options markets. All decision makers are equally likely to profit as well as to lose; luck is the sole determinant of success or failure. Uncertainty exists when the outcomes of managerial decisions cannot be predicted with absolute accuracy but all possibilities and their associated probabilities are known. Under conditions of uncertainty, informed managerial decisions are possible. Experience, insight, and prudence allow managers to devise strategies for minimizing the chance of failing to meet business objectives. Although luck still plays a role in determining ultimate success, managers can deal effectively with an uncertain decision environment by limiting the scope of individual projects and developing contingency plans for dealing with failure. Q16.2 Domestic investors sometimes miss out on better investment opportunities available to global investors. At the same time, global investors face special risks. Discuss some of the special risks faced by global investors. Q16.2 ANSWER Cultural risk is borne by companies that pursue a global investment strategy. Product market differences due to distinctive social customs make it difficult to predict which products might do well in foreign markets. For example, breakfast cereal is extremely popular and one of the most profitable industries in the United States, Canada, and the United Kingdom. However, in France, Germany, Italy, and many other foreign countries, breakfast cereal is less popular and less profitable. In business terms, breakfast cereal doesn't "travel" as well as U.S.-made entertainment like movies and television programming. Currency risk is another important danger facing global businesses because most companies wish to eventually repatriate foreign earnings back to the domestic parent. When the U.S. dollar rises in value against foreign currencies such as the Canadian dollar, foreign profits translate into fewer U.S. dollars. Conversely, when the U.S. dollar falls in value against the Canadian dollar, profits earned in Canada translate into more U.S. dollars. Because price swings in the relative value of 241 Chapter 16 currencies are unpredictable and can be significant, many multinational firms hedge against currency price swings using financial derivatives in the foreign currency market. This hedging is not only expensive but can be risky during volatile markets....
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This note was uploaded on 03/08/2011 for the course ECONABA 635 taught by Professor Leiter during the Summer '10 term at Andrew Jackson.
- Summer '10