Lecture-3-Risk+and+Return

Howeversuchbehaviorwouldnotbelikelytobenefitthe firm

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Unformatted text preview: n essence, no change in return would be required for the increase in risk. Clearly, this attitude is nonsensical in almost any business context. For the risk­averse manager, the required return increases for an increase in risk. Because they shy away from risk, these managers require higher expected returns to compensate them for taking greater risk. 12 Risk Preferences Risk Preferences For the risk­seeking manager, the required return decreases for an increase in risk. Theoretically, because they enjoy risk, these managers are willing to give up some return to take more risk. However, such behavior would not be likely to benefit the firm. Most managers are risk­averse; for a given increase in risk, they require an increase in return. They generally tend to be conservative rather than aggressive when accepting risk for their firm. Accordingly, a risk­averse financial manager requiring higher returns for greater risk is assumed throughout this text. 13 Risk Preferences Risk Preferences People will tend to be risk­seeking when it comes to losses. Thus they would rather risk a big loss in preference to suffering a certain moderate loss. This is how gamblers get hooked. Once they have made a loss, they keep gambling (sometimes in ever larger stakes) in trying to avoid the loss. On the other hand, people tend to be risk­avoiding when it comes to gains, preferring to hold onto the bird in the hand. This is the mentality of the miser. Once they have something they are loathe to risk losing it. 14 Risk Preference Behavior Risk Preference Behavior 15 Risk Assessment Risk Assessment Risk of a Single Asset The concept of risk can be developed by first considering a single asset held in isolation. We can look at expected­return behaviors to assess risk, and statistics can be used to measure it. Risk Assessment Sensitivity analysis and probability distributions can be used to assess the general level of risk embodied in a given asset. 16 Risk Assessment Risk Assessment Sensit...
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This note was uploaded on 02/11/2014 for the course MANA 2028 taught by Professor Sisterennis during the Winter '12 term at Marquette.

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