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In a financial context, risk is a synonym for uncertainty â€“ the possibility that the actual outcome will differ from the mean expected outcome. It is therefore a neutral rather than a negative concept. Investors are risk-averse in the sense that they require more return for taking on more risk. Risk itself is measured by the standard deviation of actual returns around the mean expectation. In the real world, investment risk is created by a number of different factors that affect the certain
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If the NPV is positive, then the aggregate present value of the future cash flows is greater than the price to be paid for the investment today, so the investment is cheap and offers an excess return. If the NPV is negative, then the price to be paid today is greater than the present value of the future cash flows; the investment is therefore overpriced and does not offer an adequate return. If the NPV is zero, we can say the investment is fairly priced by the market.

All significant fi
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Any investment gives rise to a stream of future expected cash flows. DCF converts all of these to an equivalent amount of present-day money (or present value) by discounting each future cash flow for the appropriate number of periods (for example, years) by the periodic discount rate. The periodic discount rate is the investor's required rate of return including the time preference rate, a premium for risk and an adjustment for inflation.

Having established the present values<
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4.1 Introduction

This section looks at how discounted cash flow (DCF) and the net present value (NPV) rule help investors to choose between possible alternative investments and decide whether the return offered on an investment is worth it, given the risk.

• DCF allows us to compare two alternative investments with different expected cash flows, different maturities and different risks.

• NPV allows us to decide whether or not to go ahead in either case.<
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3.7 Interest rate risk

This has to be seen in conjunction with the previous comments about the secondary market in shares and debt instruments. An efficient secondary market can ensure that there is always a ready buyer for an investment, but the price at which the investment can actually be sold will depend entirely on market conditions at the time of sale. The secondary market price will not necessarily bear any relation to the price originally paid by the investor. The following example illustrates the general p
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3.6 Event risk

This is not unlike default risk but it is a special case meriting its own category. The shareholders or management of a company might consciously and voluntarily enter into a major transaction that radically changes either the company's nature or its capital structure (that is, the balance and mix of shares and various types of debt in its overall sources of finance). Such a restructuring might cause some or all investors to suffer a significant increase in the uncertainty of their investment
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3.5 Default or credit risk

This is the risk that contractual returns will not be paid because the borrower's financial situation has deteriorated to the point that it is no longer able to service the debt. It is possibly the commonest type of risk in commerce generally, and you are probably familiar with it in some shape or form. It affects many areas of business decision-making over and beyond the specialised world of investment risk and return. Most large companies devote significant resources to the identification,
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3.4 Variability of income

This applies to investments where the return is defined in generic terms but the actual amount of the return may fluctuate in an unpredictable manner. As we have seen, the most obvious example is the company share, but there are others, such as debt instruments (such as many bank deposits) where there is a contractual right to interest but the interest rate fluctuates according to some formula â€“ or even simply at the whim of the bank! An important example of this type of security is the Flo
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3.3 Liquidity

Borrowers prefer to have the use of funds for as long as possible, while investors generally prefer to be able to get their money back as soon as possible. A major function of the financial markets, and of the stock market in particular, is to reconcile these conflicting requirements. The stock market enables shareholders and bondholders to realise their investment independently of the company by selling their holdings to other investors. This is called the secondary capital market, to distin
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3.2 Maturity

The maturity of an investment is the date when the investor is contractually entitled to demand repayment of the investment and the associated return. Some investments (such as company shares, as discussed in Section 3.1) actually have no contractual maturity. Others â€“ such as demand deposits at banks â€“ are subject to contractual repayment at any time if the investor demands it. If any of the other risk factors discussed below app
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3.1 Background

In practice, there is almost always some element of risk (in the technical sense of ‘uncertaintyâ€™) in any investment return. There is in finance the theoretical concept of a truly risk-free asset, but at the moment it is sufficient just to be aware of the main factors causing risk or uncertainty in practice. These are:

• maturity

• liquidity

• variability of income

• default or credit risk

• <
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2.2 Calculating returns

Our first question was: what is the mean expected total return for next year? We calculate this by taking each of the possible returns and weighting it by its relative probability. As our table is so simple and symmetrical, it is not difficult to see that the weighted mean return is 7% per annum.

Our second question was: what is the degree of risk or uncertainty in this mean figure? In other words, how widely dispersed are the possible outcomes around the mean expected outcome? The most
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2.1 Looking at each of the possible alternative outcomes

Investment risk is synonymous with uncertainty of outcome, so it is logical to try to quantify risk by looking at the relative uncertainty, or probability, of each of the possible alternative outcomes.

Suppose that we are interested in investing in the shares of Company X, and want to know:

• What is the mean or average expected total return for the next year?

• What is the degree of risk or uncertainty in this mean figure?

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1.2 Are investors risk-averse?

We will define ‘risk premiumâ€™ as an extra reward required by investors to compensate for perceived uncertainty in the amount or timing of an expected return.

But do investors in fact require an extra premium for uncertainty, or is this perhaps just a convenient assumption?

The following activity is designed to give you an opportunity to test your own reactions.

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We begin with a ‘health warningâ€™ about terminology, this time about the use of the word ‘riskâ€™ in finance.

The difference between the everyday and the specialised meanings of ‘riskâ€™ is less technical and more radical than in the case of ‘returnâ€™. In everyday usage, ‘riskâ€™ is negative â€“ the risk of having a car accident or the risk of losing one's job. If we use ‘riskâ€™ in a positive sense at all, it is only as a result of adopting a
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Next steps

After completing this unit you may wish to study another OpenLearn Study Unit or find out more about this topic. Here are some suggestions:

5 Summary

In this unit, the issues that arise in bringing a project to a close have been examined, and ways of evaluating a project have been discussed. The key components of project closure have been identified and discussed and their importance in ensuring that the aims and objectives of a project have been successfully attained, have been explored. You should now be able to plan an effective project closure. Problems often need to be resolved at the closure stage, and those managing projects need to
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4.2 Personal self-evaluation

You could also carry out a personal self-evaluation, to contribute to your own development as a project manager. You can develop a list of questions to evaluate your own performance:

• Were the project objectives achieved?

• Did the project stay within budget?

• How were problems that occurred during the project been resolved?

• What could you have done differently to improve the final result?

• <
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4.1 Introduction

Managing a project provides considerable opportunities for self-development, but these can be lost if you become too immersed in delivering the project to remember that you will move on to other work once it concludes. For many managers, taking responsibility for a project is a time-bounded task with clear objectives and a fixed budget. A project usually involves managing staff, finance, operations and information across the boundaries of departments and functions, with complicated interactio
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