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SEMESTER 2 EXAMINATIONS 2016-17

RISK TAKING AND DECISION MAKING

1. Risks ‘R’ Us Ltd decide that it is advisable to make all future strategic decisions based on the Board’s utility function. Explain, how the utility curve of the Board can be derived, how it could be used to help make decisions and discuss the value of utility analysis, particularly in situations where monetary values are not available. In explaining how the utility curve is derived for the Board you should give an example of the sorts of questions that the Board members would need to be asked. [100 marks]

2.  Emma Wang is trying to decide on her future career path. Discuss how she might tackle this problem with the aid of the normative, structured approach offered by decision analysis. Your answer should:

(a) Outline the various stages Emma should go through in reaching her decision. Discuss the purpose of each of these stages and the manner in which these stages are connected. Where possible, illustrate your answer with examples related to this career decision.         

[40 marks]

(b) Identify the advantages which such an approach might offer.

[40 marks]

(c) Describe the difficulties which Emma might experience when applying this approach in practice. [20 marks]         

3. Following the election of a new president, the USA is attempting to negotiate a free trade deal with the UK. Both the US and the UK are attempting to maximise their financial gain arising from the deal. Both US and UK realise that they can each employ one of three negotiating strategies, and the financial gain they will secure (all measured in $ billions) will depend upon the strategy employed by both US and UK. In particular, if US adopt U1 then the financial gains the US will secure are 8, 12 and 4 if the UK adopt K1, K2 and K3, respectively. If US adopt U2 then the financial gains the US will secure are 10, 12 and 4 if the UK adopt K1, K2 and K3, respectively. If US adopt U3 then the financial gains the US will secure are 10, 14 and 6 if the UK adopt K1, K2 and K3, respectively. Similarly, if the UK adopts K1, then the financial gains the UK will secure are 12, 6 and 6 if US adopts U1, U2 and U3, respectively. If the UK adopts K2, then the financial gains the UK will secure are 8, 4 and 6 if US adopts U1, U2 and U3, respectively. If the UK adopts K3, then the financial gains the UK will secure are 6, 10 and 6 if US adopts U1, U2 and U3, respectively.

(a) Draw the gain matrix to capture the information given above related to the free trade negotiations.    [10 marks]

(b) Determine the likely outcome of these negotiations and explain how a more optimal outcome for both the US and UK might be achieved.    [30 marks]

The US is also attempting to renegotiate a deal for the cost a rare mineral from Russia.  The price that US will pay per gram ($) and hence the amount that Russia will receive depends upon the strategies they both adopt as follows:

                               US’s Strategy

 

U4

U5

U6

 

R1

2

3

1

Russia’s

R2

2.5

1.5

2.75

strategy

R3

2.5

3.5

2

(If Russia employs R1 and the US employs U4 then Russia will receive $2 per gram for the rare mineral and the US will pay $2 per gram for the rare mineral).

(c) Discuss why R3, U4 might appear to be a ‘solution’ to these negotiations and explain why it is unlikely to be achieved in practice.

[20 marks]

(d) Determine the optimal strategy for the USA in these negotiations and the amount they can expect to pay for the rare mineral.          [40 marks]

4. A politician is deciding on the approach they should adopt in their election campaign in order to maximise the number of votes they will secure. She commissions some opinion polls and collects a variety of data from focus groups regarding voters’ preferences. She also consults a political analyst who provides her with their views on the chances of success using a variety of different election campaign approaches.

(a) Explain what Prospect Theory would predict about the biased manner in which the politician might make this decision. In particular, discuss the possible shape of the politician’s probability weighting function and value weighting function. Also, discuss what Prospect Theory predicts about the manner in which the politician might combine these when making her decision.

[40 marks]

(b) Explain to the politician why she should employ System 2, rather than System 1 thinking when making this decision.

[20 marks]

(c) The politician assesses the subjective probabilities of the votes she might achieve if adopting a number of different election campaign approaches. Discuss why and in what way the anchoring and adjustment heuristic might influence her subjective probability assessments and how she might minimise the impact of this heuristic on her decision making. [40 marks]

5. Following BREXIT an investment management firm, 8UR, is in the process of determining which of three alternative corporate strategies it should adopt (X, Y, Z) in order to maximise the additional clients’ funds they will attract over the next 5 years. 8UR’s economist estimates that the clients’ funds (£billions) they will attract over the next 5 years depends on whether interest rates in that period are low, medium or high. In particular, if they adopt strategy X, then she expects 8UR to secure clients’ funds (£billions) of 3, 6 and 10 if interest rates are low, medium and high, respectively.  If 8UR adopt strategy Y, then she expects 8UR to secure clients’ funds (£billions) of 4, 7 and 9 if interest rates are low, medium and high, respectively. If 8UR adopt strategy Z, then she expects 8UR to secure (£billions) of 1, 5 and 14 if interest rates are low, medium and high, respectively

(a) Discuss the relative strengths and weaknesses of the insufficient reason and maximin criteria for helping to decide which strategy 8UR should adopt (NO CALCULATION REQUIRED). [20 marks]

(b) Which strategy would 8UR adopt if they used the regret selection criterion? Outline the circumstances under which the application of this technique would be appropriate. [20 marks]

 (c) The economist now decides that the probability of interest rates being ‘medium’ is zero. If the board of 8UR are risk neutral, what must be the economist’s minimum estimate of the probability of low economic activity in order for 8UR to select strategy Y?

[20 marks]

(d) The economist now estimates that the probabilities of interest rates being low and high over the next 5 years are 0.3 and 0.7 respectively. Draw a risk/return diagram for this problem. [15 marks]

(e) Suggest alternative techniques to those indicated above which 8UR might employ to help select an appropriate strategy.

[25 marks]

6. The consultancy organisation for which you work, Uncertainty plc, has asked you to advise one of their clients. Prepare a report for the client which explains why subjective probabilities are often needed when making management decisions and outline a systematic approach they can use for probability assessment. You should also discuss the strengths and weaknesses of alternative means that they might use for quantifying subjective probabilities. [100 marks]