Meaning of Risk and Uncertainty
Risk: In Common Parlance, risk means a low probability of an expected outcome.
From business decision-making point of view, risk refers to a situation in which a business decision is expected to yield more than one outcome and the probability of each outcome is known to the decision makers or can be reliably estimated. For example, if a company doubles its advertisement expenditure, there are three probable outcomes:
Its sales may more than double
It may just double or
It may less than double.
The company has the knowledge of these probabilities or has estimated the probabilities of the three outcomes on the basis of its past experience as: i)
More than double – 10% (or 0.1)
Almost double – 40% (or 0.4) and
Less than double – 50% (or 0.5)
It means that there is 90% risk in more than doubling of the sales, and in doubling the sale, the risk is 60%, and so on.
Uncertainty: Uncertainty refers to a situation in which there is more than one outcome of a business decision and the probability of no outcome is known or can be meaningfully estimated. The unpredictability of outcome may be due to lack of reliable market information, inadequate past experience, and high volatility of the market conditions. For example, if an Indian firm, highly concentrated with population burden on the country, meant an irreversible sterility drug, the outcome regarding its success is completely unpredictable. Consider the case of insurance companies. It is not possible for them to predict the death of insured individual, a car meeting an accident or a house catching fire e.t.c.
Measurement of Risk
Risk in an investment can be quantified by using standard deviation of its returns. The calculations can be based on either. -
Expected values, or
Information about the returns.
The returns can be represented by a classic normal distribution curve, in which, 95% of result are within 1(one) standard...
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