Risk and Uncertainty in Investment Decisions

Lecture slides distinguishing risk, the set of outcomes of an event to which probabilities can be assigned because historical data exists for comparable projects, from uncertainty where no such distribution is available. Classifies the exposures a decision maker faces, including operational risk of loss from inadequate systems, management failure, faulty controls and fraud, and market risk where a price cannot be obtained because there is temporarily no appetite on the other side of the market, and works through the response options of avoiding, transferring, mitigating or keeping the exposure, with the measurement and estimation of risk exposure and the assessment of the costs and benefits of each instrument. The quantitative half compares dispersion measures, showing why the coefficient of variation rather than the standard deviation is the correct choice when alternatives differ in size, and works expected net present value through probability-weighted tables for competing machines, with discounted cash flows and present value factors, before accepting the option with the greater net present value.