Managing Risk

Using the materials from this week, address ONE of the twooptions below:

1. Congratulations! You achieved the loan you were seeking in the final assignment! Now, think about the different types of risk you will face, as you take your product or service to that next level.

• Share one (1) internal and one (1) external risk that you will encounter
• As a manager responsible for the project's success, explain what can you do to minimize their impacts

OR

2. Imagine that things are going well with your expansion efforts, but you wake up one day to find your industry has suddenly become one of the three Imperfect Competition market structures: monopoly, oligopoly,or monopolistic competition.

• What is the one Imperfect structure (monopoly,oligopoly,or monopolistic competition)most likely to occur, given the nature of your industry and its products/services?
• Who would be the dominant players?
• In what ways could this be beneficial for the consumer?In what ways could it be harmful?

JWI 515 Managerial Economics Week Ten | Lecture Two Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University. JWI 515 (1184) Page 1 of 4 RISK ANALYSIS It's a good thing you understand all about perfect competition, monopolies, monopsonies, and oligopolies. After all, the business world is a complex environment. However, even armed with that information, it's entirely possible that you and your company could still lose everything. Wait...what? It's a fact of the business world that risk exists. It exists in every type of market structure and for every firm. The reason we are focused so specifically on winning is that the opposite losing represents more than failing to achieve your goals. In worst-case scenarios, failure can represent the loss and dissolution of the entire firm. That's why it is so important to position your company for competitive advantage, not just to perform better than your competitors, but also to survive downturns in the market and other challenging economic conditions. A working knowledge of the types of risks, and the tools available to business leaders to minimize risks, is imperative if you are to make effective decisions. As a business leader, you will face risk and uncertainty every day. These conditions lie at the heart of all business decision-making, and how you choose to deal with them can be the difference between winning and losing. FORMS OF RISK There are various forms of risk. These include economic risk, business risk, market risk, interest-rate risk, inflation risk, currency risk, and expropriation risk. Economic risk is the chance of loss when all possible outcomes and their associated probabilities are unknown. Success or failure is based on luck, and all decision makers are equally likely to make or lose money. Speculative trading is a classic example of economic risk. Even faced with uncertainty, it is possible to make informed decisions. Uncertainty exists when the outcomes of a decision cannot be predicted with absolute accuracy. Still, possible outcomes and their probabilities are known and can be considered. Business risk is the possibility of loss stemming from a managerial decision. These risks are a normal result of unpredictable variations in product demand and cost conditions. For example, when Nintendo first launched the Wii, it faced a risk that sales would not reflect anticipated demand. Market risk is the chance that a portfolio of investments can lose money because of swings in the financial markets as a whole. The recession that began in 2007 caused many individuals, businesses, and governments to experience a great deal of market risk. Interest-rate risk is a primary contributor to market risk. Changing interest rates affect the value of any business agreement involving a promise to make fixed interest and principal payments over a specific time frame. If interest rates rise, the value of the fixed agreement will decline. Conversely, if interest rates fall, the value of a fixed agreement will rise. Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University. JWI 515 (1184) Page 2 of 4 Inflation risk is the danger that a general increase in the price level will undermine the value of financial instruments over an extended period. Corporate bonds and leases are classic examples of business contracts that incur inflation risk. Due to inflation, those fixed future payments will have less value or buying power. Currency risk involves a loss due to changes in the domestic currency value of foreign profits. For example, if the U.S. dollar rises against the Japanese yen, profits earned in Japan will translate into fewer U.S. dollars when repatriated back to the U.S. Losses incurred during repatriation and other factors such as income taxes are among the primary reasons why U.S. companies leave foreign profits overseas. Finally, expropriation risk is the danger that a host government will seize business property abroad. In August 2008, the Venezuelan government seized and nationalized all the plants and offices of several foreign cement companies, including Cemex, a major Mexican producer. This represented a significant loss to Cemex. WHY PROBABILITY MATTERS To effectively assess and manage risk, you need to understand probability. The probability of an event is the percentage chance that it will occur. For example, if you flip a coin, there is a 50% chance, or probability, that it will turn up heads. Expected value is the sum of the probabilities of an event occurring, multiplied by the value of the event. The sum of the probabilities must equal 1.0, or 100%. For example, if there is a 60% chance of rain, there's also a 40% chance that it won't rain. A listing of possible events (or outcomes) along with the probability assigned to each event is called a probability distribution. For a probability distribution to be complete, the sum of the probability of occurrence must also equal 1.0, or 100%. A payoff matrix can provide more detail for the manager than a simple probability distribution. The matrix is a table showing outcomes associated with each possible state. Expected value is, therefore, the anticipated result of a given payoff matrix and probability distribution. It is a weighted average payoff in which the weights are defined by the probability distribution. Risk-adjustment discount rates are based on the tradeoff between risk and return for individual investors. The risk premium is directly related to the risk associated with a particular investment. Discount rates can be adjusted for risk by adding a risk premium to the risk-free rate of return. The risk-free rate is generally considered to be the rate of a U.S. Treasury bill. Managers use the risk-adjustment valuation model to estimate appropriate investment opportunities. Because adjustments can vary due to the size of the investment project, the risk of the investment, and the attitude of the investors, deriving estimates can be challenging. Consequently, savvy business leaders use a record of past investment decisions as a guideline for determining the certainty equivalent adjustment factor. Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University. JWI 515 (1184) Page 3 of 4 A decision tree shows the outcome of the cumulative probability of a series of alternative decisions. It can be used to analyze a variety of problems, particularly those involving a series of alternatives that are constrained by prior decisions. The outcomes of a decision at each point are added to produce a total outcome, sometimes expressed in terms of net present value. Choices should be made at the highest value. UNDERSTAND RISK TO MAKE BETTER BUSINESS DECISIONS Risk, or uncertainty, is a fact of life and business. Understanding risk, and understanding the many tools available to analyze, quantify, and weigh risk and probability, allows you to make better decisions as a business leader. When you understand what is at risk, when you determine how you will respond to this uncertainty, and when you can calculate the value of the risk you are taking, you will be better prepared to make your choices...and better prepared for you and your company to win. Strayer University. All Rights Reserved. This document contains Strayer University Confidential and Proprietary information and may not be copied, further distributed, or otherwise disclosed in whole or in part, without the expressed written permission of Strayer University. JWI 515 (1184) Page 4 of 4