MS&E 107 Lecture 6: MSE107 10-13-16
13 Oct 2016
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Problem with risk management: when some risks not taken into account. Red words associated with interrelated uncertainties: correlation (co-related, covariance. Right way to determine correlation and interrelated variables: check scatter plots. Scatter plots will determine what kind of relationship exists between two variables. Literature said that people base investment decision on expected value of return (average returns) Expected value - doesn"t take risk into account. Expected return (dependent variable), risk (independent variable) - new model developed (2 by. 3 potential investments: petroleum prices in 1 year. Average expected value is and cost is sh. 95 to buy: transportation shares (united airlines stock) - cost is sh. 95 and again expected value is. : licorice candy - cost is again 0. 95 and has same expected value of . How do you allocate all the cash into these three investments? (trick question) Answer: it doesn"t matter - they have the same distribution. Portfolios: petroleum and transportation, transportation and licorice, licorice and petroleum.
