RMI 2302 Nyce Exam 1

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What is risk

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1

What is risk

Uncertainty regarding loss

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2

What do organizations add to risk

preventing reaching goals

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3

What does society add to risk

affecting a large portion of society

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4

What is risk management

Scientific approach to dealing with risk

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5

How can you classify risk

frequency- how often severity- how bad

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6

What is another word for frequency

risk likelihood

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7

What is another word for severity

risk impact

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8

What is expected value

frequency x severity

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9

How do we measure risk

relative variation of actual vs. expected variation of standard deviation

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10

What are uncertainties regarding risk

doubting ability to predict future outcomes differs across individuals when risk is the same- subjective information does not alter risk, but can alter uncertainty

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11

What are the categories of risk

pure vs speculative static vs dynamic fundamental vs particular core vs secondary

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12

Pure vs Speculative risk

pure- involve only 2 potential outcomes, loss or no loss ex. leave class and car is there or it was stolen speculative- you may have a loss or no loss but also a gain ex. buying a share of google, can go up, down, or stay the same

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13

Static vs Dynamic risk

static- unchanging through time ex. chance of earthquake dynamic- changing through time ex. identity theft

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14

Fundamental vs Particular risk

fundamental- affects large portion of population at a given time ex. hurricane particular- affects a single person or small group ex. car accident

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15

Core vs Secondary risk

core- inherent to the fundamental activities of organization ex. UPS & risk of traffic accidents secondary- not part of the core operations of an organization ex. speculative derivative trading by UPS

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16

Sources of risk

personal- related to individuals life property- related to potential damage of physical property liability- related to an individual being held liable for its actions or inactions financial- related to the financial standing of an individual or organization

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17

Exposure

person or property facing risk of loss

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18

Peril

the immediate cause or loss

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19

Harzard

condition affecting the frequency of the severity of loss

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20

Moral hazard

behavioral

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21

Morale hazard

indifference

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22

Societal hazard

legal or cultural

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23

What are attitudes toward risk

risk neutral, risk adverse, risk seeker

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24

Risk neutral

indifferent, value of risky situation is expected loss

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25

Risk adverse

prefer to avoid risk, willing to pay more than expected loss to avoid risk

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26

Risk seeker

prefer risk, would pay more than expected return to engage in risky situation

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27

What are the burdens of risk on society

need for larger emergency funds, loss of needed goods and services, fear and worry

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28

What are the rules of risk management

don't risk more than you can afford to lose, don't risk a lot for a little, consider the odds

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29

What are the risk management process steps

determination of objectives identification of risks evaluation of risks consider the alternatives implement the decision evaluate and review

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30

Determination of objectives

Post-Loss Objectives: Survival, Continuity of Operations, Earnings Stability, Continued Growth, Social Responsibility

Pre-loss objectives: economy, reduction in anxiety, meeting externally imposed obligations, social responsibility

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31

Identification of risks

the preferred approach to risk identification is a combination approach

  • interviews

  • analysis of documents

  • inspections

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32

Evaluation of risks

loss frequency- probability distributions loss severity- maximum possible loss, probable maximum loss law of large numbers- enables us to work small premiums for larger uncertain loss

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33

Consider the alternatives

loss control- reduced level of risky activity, increased precautions loss financing- relation and self insurance, hedging, etc internal risk reduction- diversification, investments in information

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34

What is risk control

techniques aimed at reducing number of risks faced or amount of loss

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35

What are the types of risk financing

planned vs unplanned funded vs unfunded

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36

Planned vs unplanned

You can create a retention plan (I will pay for any losses out of my savings account) or you can just wing it (if a loss occurs, I'll figure it out).

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37

Funded vs unfunded

You can create an account and put money into it to pay for future losses (funded), or you can pay it out of cash flow or other sources not specifically earmarked for losses(unfunded).

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38

How is risk viewed differently at a societal level

scientific view of risk adds the time element

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39

What happens when you add the time element in risk

information gets ignored ex. is it fair for a younger person dying before an older person

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40

What is the best alternative for the time element

using the number of days lost

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41

What does risk reduction do

there is monetary and non-monetary, puts a value on human life

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42

What are the rules of thumb to minimize risk

  1. recognize you need a model- mental model(semiconsciously in mind)

  • mathematical model (more precision)

  1. acknowledge your models limits- incorrect(logic or assumptions are wrong, do not use this)

  • incomplete (characteristic shared by all models, add to this)

  1. expect the unexpected - some factors will be overlooked (changes in environment and interaction can create factors that are no longer relevant)

  2. understand the use and user -models are evaluated as a triplet (model, application, user)

  • workings of a model are transparent, consistently applied, results can be reproduces and verified by others

  1. check the infrastructure - benefits are determined how innovation is introduced

  • pace is different, can cause imbalance

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43

Risk vs. Reward

the higher the risk the higher the reward

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44

What is decision theory

Used to determine optimal strategies where a decision-maker is faced with several alternatives and an uncertain, or risky, pattern of future events

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45

What are the steps of the decision making process

identification of various possible outcomes (no control) identification of all courses of action (control) determination of the pay-off function (combination of acts and outcomes) choosing from among various alternatives on the basis of some criterion

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46

Pay-off

represents the matrix of the conditional values associated with all the possible combinations of acts and events

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47

Opportunity loss/regret

the amount of profit foregone by not adopting the optimal course of action, or that which would give the highest pay-off for each possible event.

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48

What are the pay-off matrix requirements

must not be a sequence of events courses of action and events must be clearly determined events of actions must be distinct, mutually exclusive and collectively exhaustive

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49

Laplace principle

do not know the probabilities, assume all outcomes are equal

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50

Maximin/Minimax principle

for risk adverse people, figure out the worst possible outcome in each scenario and pick best WORST case

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51

Maximax/Minimin principle

for optimistic people, figure out the best case scenario, pick out the BEST possible outcome

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52

Maximum likelihood principle

figure out which scenario is most likely to occur and then make the choice that maximizes profit with that scenario

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53

Expectation principle

take the probability X outcome and add them altogether

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54

Multi-stage decision proccess

rollback technique- proceeding in a backwards manner, decide later stages then earlier stages

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55

Expected value

= probability X outcome add altogether

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56

What is the importance of understanding individual decision making

individuals tend to be risk adverse, they prefer the sure thing rather than an uncertainty

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57

What is the difference between organizational and individual decision making

organizational uses expected value individuals use expected utility

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58

What is the utility theory

utility is a function of wealth increasing in wealth increasing at a decreasing rate

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59

What is a utility function

probability X utility of the outcome square root function

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60

What is certainty equivalent

what the square root is, where you take the risk

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61

What are the common mistakes in decision making

ignoring implicit costs- if doing x means not being able to do y, the value of y is an opportunity cost to x failing to ignore sunk costs- may be relevant, but are not and should be ignored measuring costs and benefits as proportions rather than absolute dollar amounts- driving to save $10 on $20 and $10 on $1010 should be answered the same because it is the same amount failure to understand average-marginal distinction- must compare the benefit and cost of an additional unit of activity

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62

What is the invisible hand

The idea that people pursuing their own self-interest actually benefit the public at large, making decision based on own best interest ex. i do not have to get vaccinated if everyone else does

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63

Decision makers delimma

do not experience sediments that motivate people to vote, return lost wallets, etc care only about personal material costs and benefits

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64

Postive vs Normative questions

normative- what should be ex. should we protect x positive- what will the consequences be ex. what will happen to x

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65

Households

many households work for someone else wages/salaries are how we get compensated

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66

Income

not evenly distributed, rich get richer and poor get poorer spend money on taxes personal saving personal consumption expenses (service we spend most money on)

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67

What are forms of business

sole proprietorship- what most businesses are corporations- biggest

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68

Advantages for corporations

most effective for raising money limited liability expand easily due to attracting capital life dependent of owners and capital

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69

What is the principle agent problem

when principals and agents interests are not aligned, owners want maximum company profit and stock price, but agents want power, high pay regardless of company performance

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70

principals

stockholders

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71

agents

hired by stockholders to run business

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72

What is the governments role

-Provide Legal Structure -Maintaining Competition -Redistributing Income -Reallocating Resources -Promote Stability

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73

Provide legal structure

Sets legal status of business enterprise Ensure rights of ownership Enforcement of contracts Establishes the rules

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74

Maintain competition

efficient competition= high competition monopoly= controlling supply

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75

Redistributing income

transfer payments- provide relief (welfare checks) market intervention- gov modifies prices (minimum wage taxation- gov uses income tax to take more from the rich so it narrows after-tax income differences

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76

Reallocating resources

-Externality - occurs when some of the cost or the benefits of a good are passed on to someone other than the immediate buyer or seller. -Negative externality - Production or consumption costs inflicted on a third party without compensation -Correcting negative externalities --Legislation --Specific taxes - tax confined to a particular product -Positive externality - externality that appears as a benefit to other producers/consumers, like immunizations or education. -Correcting positive externalities --Subsidize consumers (low-interest loans for college) --Subsidize suppliers (public colleges) --Provide goods via the government (postal service)

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77

Promote stability

when total spending matches economy's production capacity the prices are stable stability is achieved when addressing unemployment and inflation

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78

How do we balance competing goals

if the free market worked well, we would not have to worry about the government protecting ourselves from ourselves government could focus on externalities in economic perspective people get "different pieces of the pie"

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79

How do we maximize with measurment

Bentham- urged politicians to design policies that maximized peoples happiness treat to libertarians- replaces the individualized version of well being "happy slave"- poor your whole life and happy, does that make it okay

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80

Is there a simple answer for happiness

no, in policy decisions there needs to be a balance between number of competing objectives when making these decisions education, freedom, well-being is measured would we get a better idea of what we really want the government to do

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