BUSI 620 CT 7 final draft
Business 620
Critical Thinking Seven
Salvatore's Chapter 14:
a) Discussion Questions: 12 and 15.
b) Problems: spreadsheet problems 1 and 2.
Discussion Question 12: What is the rationale behind the minimax regret rule? What are some of the less formal and precise methods of dealing with uncertainty? When are these useful?
The minimax regret rule is a strategy usually used by risk neutral management. The goal of this strategy is to minimize the maximum possible regret that would be incurred as a result of making the wrong decision. When using the strategy, management would select the option with the lowest regret, also called opportunity cost, based on the assumption that the maximum regret will occur for all of the available decision options. The difficultly with this strategy is that probabilities of outcomes are hard to estimate.
Other ways to deal with uncertainty consist of gathering additional information about each option, developing controls such as patents and copyrights, diversifying product lines, and increasing security holdings. These approaches help a company minimize risk and uncertainty when it is difficult to gasp insight quantitatively.
Discussion Question 15: How does the adverse selection problem arise in the credit-card market? How do credit-card companies reduce the adverse selection problem that they face? To what complaint does this give rise?
Adverse selection is created by asymmetric information before a transaction takes place. In the credit card market, it occurs when potential borrowers who are more likely to produce an undesirable outcome (bad credit/high risk) are the ones who most actively seek out a loan.
To reduce the adverse selection problem, credit card can raise interest rates to reduce the risk of defaulting on loans. However, this can cause a problem because higher interest rates will weaken the economy.
Spreadsheet Problem 1: An individual has to choose between investment A and investment B. The individual estimates
Critical Thinking Seven
Salvatore's Chapter 14:
a) Discussion Questions: 12 and 15.
b) Problems: spreadsheet problems 1 and 2.
Discussion Question 12: What is the rationale behind the minimax regret rule? What are some of the less formal and precise methods of dealing with uncertainty? When are these useful?
The minimax regret rule is a strategy usually used by risk neutral management. The goal of this strategy is to minimize the maximum possible regret that would be incurred as a result of making the wrong decision. When using the strategy, management would select the option with the lowest regret, also called opportunity cost, based on the assumption that the maximum regret will occur for all of the available decision options. The difficultly with this strategy is that probabilities of outcomes are hard to estimate.
Other ways to deal with uncertainty consist of gathering additional information about each option, developing controls such as patents and copyrights, diversifying product lines, and increasing security holdings. These approaches help a company minimize risk and uncertainty when it is difficult to gasp insight quantitatively.
Discussion Question 15: How does the adverse selection problem arise in the credit-card market? How do credit-card companies reduce the adverse selection problem that they face? To what complaint does this give rise?
Adverse selection is created by asymmetric information before a transaction takes place. In the credit card market, it occurs when potential borrowers who are more likely to produce an undesirable outcome (bad credit/high risk) are the ones who most actively seek out a loan.
To reduce the adverse selection problem, credit card can raise interest rates to reduce the risk of defaulting on loans. However, this can cause a problem because higher interest rates will weaken the economy.
Spreadsheet Problem 1: An individual has to choose between investment A and investment B. The individual estimates