Performance Objective: Examine the concept of financial risk by answering the following questions:

(a) How are certainty, uncertainty, and risk related?

(b) How do financial managers measure risk?

(c) How much does risk matter in financial decision making?

(d) Why does portfolio diversification usually help financial managers to reduce risk?

(e) Describe a practical decision making situation in which it is important for a financial manager to estimate at least one of the following types of financial risk: interest rate risk, default risk, inflation risk, illiquidity risk, exchange rate risk, political risk, unique risks, or market risks.

(f) How is the risk premium demanded by an investor for assuming a certain type of risk related to the investor's degree of risk aversion?