Econ Chapter 16
Terms
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- absolute risk
- Overall dispersion of possible payoffs
- beta
- Measure of the systematic variability of one asset’s returns with returns on other assets
- business risk
- Chance of loss associated with a given managerial decision
- certainty equivalent
- Assured sum that equals an expected risky amount in utility terms
- certainty equivalent adjustment factor, a
- Ratio of a certain sum divided by an expected risky amount, where both dollar values provide the same level of utility
- chance events
- Possible outcomes following each decision point
- computer simulation
- Use of computer software and workstations or sophisticated desktop computers to create outcome scenarios
- cost of uncertainty
- Minimum expected opportunity loss
- credit risk
- Chance that another party will fail to abide by its contractual obligations
- cultural risk
- Chance of loss because of product market differences due to distinctive social customs
- currency risk
- Loss due to changes in the domestic-currency value of foreign profits
- decision points
- Instances when management must select among choice alternatives
- decision tree
- Map of a sequential decision-making process
- derivative risk
- Chance that volatile financial derivatives such as commodities futures and index options could create losses in underlying investments by increasing rather than decreasing price volatility
- diminishing marginal utility
- When additional increments of money bring ever smaller increments of added benefit
- Dutch auction
- Winning bidder is the first participant willing to pay the auctioneer’s price
- economic risk
- Chance of loss due to the fact that all possible outcomes and their probability of occurrence are unknown
- English auction
- Most familiar type of auction where an auctioneer keeps raising the price until a single highest bidder remains
- expected value
- Anticipated realization
- expropriation risk
- Danger that business property located abroad might be seized by host governments
- game theory
- Study of human interaction and decision strategy
- government policy risk
- Chance of loss because foreign government grants of monopoly franchises, tax abatements, and favored trade status can be tenuous
- inflation risk
- Danger that a general increase in the price level will undermine the real economic value of any legal agreement that involves a fixed promise to pay over an extended period
- interest-rate risk
- Market risk that stems from the fact that changing interest rates affect the value of any agreement that involves a fixed promise to pay over a specified period
- liquidity risk
- Difficulty of selling corporate assets or investments that have only a few willing buyers or are otherwise not easily transferable at favorable prices under typical market conditions
- market risk
- Chance that a portfolio of investments can lose money because of swings in the financial markets as a whole
- maximin criterion
- Decision choice method that provides the best of the worst possible outcomes (also a secure strategy)
- minimax regret criterion
- Decision choice method that minimizes the maximum possible regret (opportunity loss) associated with a wrong decision after the fact
- normal distribution
- Symmetrical distribution about the mean or expected value
- opportunity loss
- Difference between a given payoff and the highest possible payoff for the resulting state of nature
- payoff matrix
- Table that shows outcomes associated with each possible state of nature
- probability
- Chance of occurrence
- probability distribution
- List of possible events and probabilities
- relative risk
- Variation in possible returns compared with the expected payoff amount
- risk aversion
- Desire to avoid or minimize uncertainty
- risk neutrality
- Focus on expected values, not return dispersion
- risk premium
- Added expected return for a risky asset over that of a riskless asset
- risk seeking
- Preference for speculation
- risk-adjusted discount rate
- Risk-free rate of return plus the required risk premium
- risk-adjusted valuation model
- Valuation model that reflects time-value and risk considerations
- sealed-bid auction
- Auction where all bids are secret, and the highest bid wins
- sensitivity analysis
- Limited form of computer simulation that focuses on important decision variables
- standardized variable
- Variable with a mean of 0 and a standard deviation equal to 1
- uncertainty
- When the outcomes of managerial decisions cannot be predicted with absolute accuracy but all possibilities and their associated probabilities of occurrence are known
- Vickrey auction
- Where the highest sealed bid wins, but the winner pays the price of the second-highest bid
- winner’s curse
- Where overly aggressive bidders pay more than the economic value of auctioned off items