Risk and Uncertainty New
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Transcript of Risk and Uncertainty New
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RISK AND UNCERTAINTY
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GroupMembers
Atul P Mumbarkar
44
Nimesh S Sawant 65
Praful Bhalerao 4
Rahul H Kadam 23
Umesh More - 41
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Introduction Inrealworld,mostfutureeventsarenotknown
touswiththeirdegreeofcertainty.
Managersaresupposedtotakedecisionrelying
onsomeestimateswhichagaininvolvessomeuncertainty.
So,Riskanduncertaintywillalwaysbeapartofouranalysis.
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WhatisRisk?
Riskreferstothesetofuniqueoutcomesforagiveneventwhichcanbeassigned
probabilities
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Inotherwords,wecanalsodefineriskas,aprobabilityorthreatof
adamage,injury,liability,loss,orothernegativeoccurrencethatiscausedbyexternalor
internalvulnerabilitiesandthatmaybeneutralizedthroughpreemptiveaction.
WhatisRisk?
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WhatisUncertainty
Uncertaintyreferstotheoutcomesofgiveneventwhicharetoounsuretobeassigned
probabilities
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WhatisUncertaintyIn other words, we can define Uncertainty as a
decision making situation where the current stateofknowledgeissuchthat
theorderornatureofthingsisunknown,
theconsequences,extent,ormagnitudeofcircumstances,conditionsoreventsisunpredictableand
credibleprobabilitiestopossibleoutcomescannot
beassigned.
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RiskV/sUncertainty
Riskiswhenfutureeventscanbedefinedandprobabilitiescanbeassignedanduncertaintyiswhen future events cannot be defined andprobabilities of it occurrence cannot be
assigned.
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Risk and Uncertainty are concepts that talkabout expectations in future, butwhereas youcan minimize risk by taking some preventivemeasures to face an uncertain future, but youcannotremoveuncertaintyfromlifealtogether.
RiskV/sUncertainty
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RiskiswhenweknowtheoutcomeofanygivenactivityoreventbutUncertaintyiswhenwedonotknowanythingabouttheoutcomeof
anygivenactivityorevent.
RiskV/sUncertainty
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Riskiscalculableandmeasurablewhileuncertaintyisnot.
RiskV/sUncertainty
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Risk,ifcalculated,canbeinsured.
Thus,insurancecompaniescanpredictwithahighdegree of accuracy the probabilities of deaths,accidents, and fire losses. These probabilities
enable them to make decisions about premiumlevelsanrates.
RiskV/sUncertainty
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Adecisionmaking situation in which the possibleoutcomes can vary and the probability of theoccurrenceofeachoutcomeisknownissaidtobeariskysituation
While a decision making situation, in which thepossible outcome aremany and the probability ofthese outcomes are not known is said to anuncertainsituation.
RiskV/sUncertainty
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RiskAttributes Risk Aversion:Individuals seek to avoid or minimize risk. Adescription of an investor who, when facedwithtwo investments with a similar expected return
(but different risks), will prefer the one with thelowerrisk.
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Manhole
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RiskAttributes Risk Neutrality:Individuals focus on expected returns anddisregard the dispersion of returns (risk). A risk-neutral investor is more concerned about the
expectedreturnonhisorherinvestment,notonthe risk he or she may be taking on.
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Manhole
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RiskAttributes Risk Seeking:Individualspreferrisk.
Riskseekersmightpursueinvestmentswhicharerisky.
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Manhole
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RiskAttributes Choice between more risky and less risky
investmentswithidenticalreturns:
Riskaverterchoosestheonewithlessrisk
Riskseekerchoosestheonewithhighrisk
Riskneutralisindifferentbetweenthechoices
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TypesofRisk
Types ofRisks
MARKETRISK
CREDIT RISK
LIQUIDITYRISK
OPERATIONALRISKLEGAL AND
REGULATORYRISK
BUSINESSRISK
STRATEGICRISK
REPUTATIONRISK
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MarketRisk Market risk is the risk that changes in financialmarketpricesandrateswillreducethemonetaryvalue (e.g. Rs., US $, UK ) of a security or aportfolio.
Therearefourmajortypesofmarketrisk
1. InterestRateRisk
2. EquityPriceRisk
3. ForeignExchangeRisk
4. CommodityPriceRisk
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TypesofMarketRisk Interest Rate Risk: Thesimplestformofinterest
rate risk is the risk that the value of a fixedincomesecuritywillfallasaresultofanincreaseinmarketinterestrates.
Equity Price Risk: The risk associated with
volatilityinstockprices.Thegeneralmarketriskofequityreferstosensitivityofaninstrumentor
portfoliovaluetoachangeinthelevelofboardstockmarketindices.
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Foreign Exchange Risk:Foreign exchange risk arises from open or
imperfectly hedged positions in a particular
currency. These positions may arise as anatural consequence of business operation,ratherthanfromanyconsciousdesiretotakeatradingpositioninacurrency.
TypesofMarketRisk
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Commodity Price Risk:Thepriceriskofcommoditiesdiffersconsiderablyfrom interest-rate and foreign exchange risk,
sincemostcommoditiesaretradedinmarketinwhichtheconcentrationofsupply inthehandofafewsupplierscanmagnifypricevolatility
TypesofMarketRisk
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CreditRisk
Creditriskistheriskthatachangeinthecreditqualityofcounterpartywillaffectthevalueofsecurityoraportfolio.
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LiquidityRisk
Liquidityriskcomprisesbothfundingliquidityriskand asset liquidity risk, although these twodimensionofliquidityriskarecloselyrelated.
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LiquidityRisk
Funding liquidity risk relates to a firmsabilitytoraisethenecessarycashtorolesoveritsdebt;tomeet the cash , margin and collateralrequirementsofcounterparties:and(inthecase
offund)tosatisfycapitalwithdrawals.
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LiquidityRisk
Assetliquidityrisk,oftensimplycalledliquidityrisk,is the risk that an institution will not be able toexecute a transaction at the prevailing market
pricebecausethereis,temporarily,noappetiteforthedealontheothersideofthemarket.
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OperationalRisk
Operational risk refers to potential lossesresultingfrominadequatesystem,managementfailure,faultycontrols,fraud,andhumanerror
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LegalandRegulatoryRisk
Legal risk is a type of risks that means that acounterparty is not legally able to enter into acontract. Another legal risk relates to regulatory
risk, i.e., that a transaction could conflict with aregulator's policy or, more generally, thatlegislation might change during the life of afinancialcontract.
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BusinessRisk
Business risk refers to the classic risk of theworldofbusiness,suchasuncertaintyaboutthe
demand for products, the price that can bechargedforthoseproducts,orcostofproducinganddeliveringproducts
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StrategicRisk
Strategic risk refers to the risk of significantinvestments for which there is high uncertaintyaboutsuccessandprofitability.Iftheventureisnotsuccessful,thenthefirmwillusuallysufferamajor
write-off,anditsreputationamonginvestorswillbedamaged.
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ReputationRisk
Reputationriskistheriskofcausinganyharmtothereputationofanyindividualororganizationincase of any scam or scandals. For example,
there was a reputation risk to Price WaterCooper house accounting firm due to Satyamscam.
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General Methods of Dealing with Uncertainty Referral to authority for guidance:This is a very pragmatic to the reduction ofuncertainty.Insomecases,thereisliteralauthoritysuch as wage boards, industrial relations
commission ,bureau of industrial costs and prices.Whatever such authorities decide, managementacceptsthem
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Control of the environment:Thisapproachusuallytakesthefromofattemptsto gain a monopoly by means of patents,
exclusive dealership, contacting and influencingimportantofficialswhomatteretc.
General Methods of Dealing with Uncertainty
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Hedging:It is a very common method by which businessexecutivescan replace futureuncertaintywith thesecurityofapresentcontract.hedgingtakesmany
forms;itemergesmostcommonlyinthewritingofcontractsforgoodsandservices,andittradingof
futuresatcommodityexchanges.
General Methods of Dealing with Uncertainty
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Diversification:Thisiscloselyrelatedtoflexibility.Thereisanoldadagedontputallyour-eggsinonebasket".in
view of this, to minimize risk and uncertainty,business often, go for diversification of theirproducts,sourceofrawmaterials,marketsetc.
General Methods of Dealing with Uncertainty
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Modification of goals:In the face of complete uncertainty, an optimaldecisionmightbeimpossible.Knowingthis,many
timesabehavioral firm, youmay recall, attemptsmodificationofitsgoal-itstargetvariables.Thisisa practical approach to face the uncertainenvironment.
General Methods of Dealing with Uncertainty
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Flexible investments:The investor often takes care of flexibility whiledeciding on long run investment. For example, a
general-purposemachine.but whenchangesandfrequent, it is less riskier to invest in a general-purposemachine.
General Methods of Dealing with Uncertainty
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Purchasing Insurance:We all purchase insurance policies that involves paying apremiumtoprotectourselvesagainstdifferentkindsofrisks-accident,fire,death,etc.Insuranceiscommonlyavailablefor losses due to fires, accidents at workplace, theft andfraud.whetheraninsuranceisrequiredornotdependsonthe degree of risk averseness of the buyers, theirassessmentoftheseverityoftheconsequencesoftheeventoccurring,andthepremiumitself.
General Methods of Dealing with Uncertainty
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