Unformatted text preview: utcomes of the
probability distribution are. The range is calculated as the difference between the best and the worst
Range = Best possible outcome - Worst possible outcome
For Product A, the range of possible outcomes is $10,000 - (-$1,000) = $11,000. The larger the range,
the farther apart are the two extreme possible outcomes and therefore more risk. The standard deviation
Though easy to calculate, the range doesn't tell us anything about the likelihood of the possible cash
flows at or between the extremes. In financial decision-making, we are interested in not just the extreme
outcomes, but all the possible outcomes.
One way to characterize the dispersion of all possible future outcomes is to look at how the outcomes
differ from one another. This would require looking at the differences between all possible outcomes and
trying to summarize these differences in a usable measure.
An alternative to this is to look at how each possible future outcome differs from a single value,
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- Spring '07