RMI 2302 - Exam 2 Summary

RMI EXAM 2
MODULE 6
Risk/ Reward – employers want employees who can make critical decisions. Risk/ reward trade off
depends on the person level of risk aversion
 Individuals
o use expected utility
o How much reward is necessary to induce you to take risk?
o Similarly, how much are you willing to pay to avoid risk?
o This is actually the entire basis of insurance, people willing to pay to avoid
risk Ex) - $5 wealth-- 50/50 chance of ending up with $1 or $9 dollars
o utility function is the sq. root function
o how much reward is necessary to get the individual to take the risk?
o Ways (categories) of looking at risk at the individual level
 Property  Health
 Liability  Financial
 Life
 Why categorize?
 risk management techniques) (categories may not be mutually
exclusive (some risks may appear in multiple categories)
 Organizations
o Organizations use expected value, due to less variation
o NO natural risk aversion- some willing to take more risk: high risk, high
reward. Others- low risk- low reward
o Use opportunity cost/ cost of capital to measure risk and reward
o most organizations project future cash flows from investments/ opportunities
so they will discount those cash flows back to present value based on cost of
capital
 cost of capital is commensurate with riskiness of firm
o riskier orgs = higher cost of capital and higher interest rate/discount rate.
Cash flow won’t change, but OC and discount rates do change
 Gov't/ Society
o Measuring reward to society is difficult (reward of national parks)- many times
government is the only entity able to take on risk, regardless of reward and
often provide incentives

 proper decision making implied that any individual, org, and govt willing to take on
additional risk should be compensated with some type of additional reward. Levels of
risk should have same level of reward.


Bias
 Subjective view/probability – one sided, lack neutral point of view that alters the decision
making
 problem when it ends up being significantly different from the model- they don’t account
for biases on part of decision maker.

, RMI EXAM 2
 We cannot model the unknown unknowns which make model wrong. Bias shows
that our model is off- we are overestimating/ underestimating
 Type of Bias
o Age bias- peeps in certain age groups tend to interpret information about risk
differently
o Cultural biases- certain culture view of risk differ- religion biases
o Experience biases- peeps who have experienced a low- probability/ high
consequences event will overestimate the likelihood; peeps not experience one--
underestimate
o Gender biases- cannot sat all men or women think a certain way
o Media biases- risks that garner a lot of social/ media attention (murder, terrorism,
kidnapping, etc.) are typically overestimated, while other risk (car accidents,
health risks) are underestimated
 High frequency, low severity= overestimated
 Low frequency, high severity= underestimated

Incentives
 Incentives motivate individuals to perform an action.
 Incentives can be at the individual level, organizational level, or societal level.
 Generally, we refer to incentive structures
o Economics = study of incentive systems
 Beware: "law of unintended consequences"
 Political incentives
o (short term vs. long term planning)
o (discount rate)
 Types of incentives
o Financial:
 Most incentives come from there. These exist when an agent can expect
some form of material regard in exchange for acting in a way
o Moral: "do the right thing"
 peep can expect a benefit of self-esteem and approval from the
community- doing the right thing
 peep ignore this will feel sense of guilt and condemnation from the
community
o Natural:
 curiosity, fear, anger, pain, joy, pursuit of happiness
o Coercive:
 negative reinforcement. Failure will act in a way that result in a physical
force being used against them by others. Punishing behavior
o Personal:
 Motivate peep through their preferences, desires and ambitions. Why
someone acts the way that they do
o Social:
 Situation faced by any individual in a given position within a society by
taking account of the societal norms, rules…

, RMI EXAM 2
o Orgs get peeps to buy products through advertising and loyalty programs
o Law of unintended Consequence- outcomes not intended by a purposeful action
but it happens
MODULE 7
Loss Exposures
 Any condition or situation that presents a possibility of loss, regardless of whether that
loss actually occurs
 Individual Risk Management- looking at risk at the individual level
1. Property
2. Liability- threat of being sued for money
3. Life
 Premature death
 Long life
4. Health
5. Financial
 Three elements to a loss exposure- any situation that presents possibility of loss
regardless whether loss occurs or not
1. asset exposed to loss
2. cause of loss
3. financial consequences of the loss


 Types of loss exposure
1. Property
 Asset exposed to loss
 real property: land buildings, crops, etc...
 personal property: your stuff: furniture, jewelry, art, autos, watercraft, etc.

 Cause of Loss
 Fire theft, windstorm, accidents, loss, anything you can think of
 Financial Consequences
 Reduction in property value- its immediate, the minute you buy
something
 Increased expenses
 Lost income- if property is used to make income, when you lose
the property, you lose the income


2. Liability- being held liable for actions/ inactions
 Asset exposed to Loss
 Money/income/ other financial assets/ freedom/ jon
 Types of damages
o 1. General Damages- someone lost income b/c you hurt
them—can’t work due to injury