1 / 20

Risk Analysis

Risk Analysis. “Risk” generally refers to outcomes that reduce return on an investment. Meaning of Risk. Potential for revenue to be lower and expenditures to be higher than “expected” when investment was made. Measured by variation in these factors Causes

trapper
Télécharger la présentation

Risk Analysis

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Risk Analysis “Risk” generally refers to outcomes that reduce return on an investment

  2. Meaning of Risk • Potential for revenue to be lower and expenditures to be higher than “expected” when investment was made. • Measured by variation in these factors • Causes • Physical risk – physical loss of growing stock due to acts of God or uncontrollable acts of man • Market risk – changes in markets that cause variation in revenues and costs • Financial risk – changes in interest rates and associated opportunity cost

  3. Meaning of Uncertainty • No basis for estimating probability of possible outcomes • No experiential data

  4. Probability Distribution • Relationship between possible outcomes and the percentage of the time that a given outcome will be realized if the process generating the outcomes is repeated 100’s of times.

  5. Mean = $6,000 Probability of 50% Mean = $2,000 Probability of 25% Mean = $10,000 Probability of 25%

  6. Expected Revenue • EVR = E(R) = ∑ PmRm N m Where, m = index of possible outcomes N = total number of possible outcomes P = probability of mth outcome R = possible revenues

  7. Expected revenue of example • E(R) = 0.25 x $2,000 + 0.5 x $6,000 + 0.25 x $10,000 • = $6,000 • Call this investment “risky”

  8. Risk aversion • Assume an investment with $6,000 future revenue that is guaranteed by US Government • E(R) = $6,000 x 1.0 = $6,000 • Call this investment “guaranteed” • If an investor prefers the $6,000 guaranteed in the example above, to the $6,000 risky investment in the previous example they are “risk averse” • Have no tolerance for risk

  9. Risk aversion • If an investor is indifferent between the guaranteed $6,000 and the risky $6,000 then they are “risk neutral” • If an investor prefers the risky $6,000 to the guaranteed $6,000 then they are “risk seekers” • They are willing to take a chance that they will get a return greater than $6,000

  10. Risk-Return Relationship • Because all investors have some risk aversion investment market must reward investors for taking higher risk by offering a higher rate of return in proportion to the risk associated with an investment

  11. Variation • Sum of squared deviations from expected revenue weighted by probability of outcome • Variance = σ2 = ∑ [Rm – E(R)]2 Pm • Standard deviation = (σ2 )1/2 N m=1

  12. Example

  13. Comparing standard deviations • Risk is higher if standard deviation is higher, but • If expected values vary can’t compare their variation • Need measure of relative risk, • Coefficient of variation = • Standard deviation / E(R) • For example: $2,828/$6,000 = 0.47 • Standard deviation is 47% of expected value

  14. Risk-free rate of return • Risk-free rate assumption – rf = 3% is still a valid assumption • Correct PV is (risk-free revenue)/(1+ rf)n • Example $6,000/(1.03)5 = $5,176 Buy U.S. Treasury bond for $5,176, get $6,000 at maturity in 5 years

  15. Real Risk-Free Interest Rate 10-Yr. Treas. Sec., 3-Yr. Moving Average

  16. Risk Averse Investors • Will only pay less than $5,176 for $6,000 5-year bond, i.e. • Discount $6,000 bond at rate of >3% • (risky E(R))/(1+RADR)n< (risk-free E(R)/(1+rf)n • How do we find risk-adjusted discount rate (RDAR)? • Get investor’s certainty-equivalent (CE) • Example, what risk-free return is analogous to $6,000

  17. “Back Into” RDAR • Correct present value = CE/(1+rf)n = PVCE = (E(R))/(1+RADR)n (1+RADR)n = E(R)/PVCE RADR = (E(R)/PVCE )1/n -1 • Example, CE = $4,000 Correct PV = $4,000/(1.03)5 = $3,450 RADR = ($6,000/$3,450)1/5 – 1 = 11.7%

  18. Risk Premium • k = RADR –rf =11.7% - 3% = 8.7% • No “general rule” about what risk premium is or should be

  19. Relative Measure of Risk • Certainty-equivalent ratio, cr cr =CE/E(R) Example, cr =$4,000/$6,000 = 0.67 k = (1+rf)/(cr1/n) – (1+rf) = 1.03/0.670.20 – 1.03 = 8.6% • See Table 10-2 • Higher risk equates to smaller cr

  20. Relative Measure of Risk • See Table 10-2 • Higher risk equates to smaller cr • Risk premiums decrease with longer payoff periods • If know an investors CE don’t need RADR

More Related