Relation of profit with risk and uncertainty

The profit is always connected with uncertainty in the future. If everything was known beforehand, no new undertaking would be needed, scientific and technological progress would be necessary, and the profit would therefore be immutable as entrepreneurs would not risk. Risk theory shows that susceptibility to innovation is alternative to uncertainty in future economic processes and the associated risk. The presence of risk as a satellite of the alleged profit was considered for four decades by Professor Frank Knight of the University of Chicago (1885-1962). His theory is based on the following examples.

Example one. Suppose the broker was able to guess about the upcoming increase in wheat prices. Thanks to this he was able to earn one million dollars for Sunday. Knight says: "This is exactly what I had in mind. If the future development prospects were absolutely certain, then the market would take into account the inadequate supply of wheat in the subsequent period and it would be impossible to secure such profits. "

Example of the second. The broker, assuming that the wheat will grow in price, made a mistake and was ruined. Here, according to Knight's theory, profits "can be negative and positive. Uncertainty creates a discrepancy between what people expect, and what really happens. The quantitative expression of this discrepancy is Profit or Loss.

Confirming this theory, practice shows that a real entrepreneur aims not to achieve maximum profit, but to obtain its steady growth. Here is a classic example: while people buying lottery tickets, face uncertainty in obtaining a win, the lottery founders are practically not exposed to any risk. Similarly, a large industrial company can rely on the mathematical laws of probability theory to calculate its investment in such a way as to reduce the relative risk. How? The point is that the risk distribution is more or less uniform if the total amount of capital investments is sufficiently large, i.е. the so-called effect scale. This is the basis for the activities of large enterprises.

The risk and ways to measure it

The concept and classification of economic risk

In economic theory, the following types of risk are distinguished, which bark at the opportunity to make a profit:

• risk of non-payment of a dividend;

• clean risk, or the actual risk associated with objective production processes;

• The risk arising from innovations, the implementation of which will help entrepreneurs to profit for the implementation of new ideas.

Risk can be classified by sources and causes of occurrence, as well as from qualitative and quantitative positions. Depending on the source of occurrence the economic risk is singled out; risk associated with the person; risk due to natural factors. Each of these risks has a corresponding cause of occurrence, dependence on the cause of occurrence distinguish risk as a consequence of uncertainty; risk of unpredictability of partners' behavior; risk of lack of information.

As market relations develop, competition intensifies, which leads to innovation, which inevitably increases the risk. This leads to solving problems associated with numerical risk assessment. Risk-related tasks usually consist of choosing a certain alternative, which provides the best result with a given probability, for example, Pr, and the worst probability : 1 - And. From the point of view of qualitative certainty, three categories of risk can be distinguished:

• admissible risk - threat of a complete loss of business profits;

• Critical risk - loss of costs for entrepreneurial activities. In this case, all the estimated revenue is lost and the costs have to be reimbursed at your own expense;

• catastrophic risk - there is a loss of all property and bankruptcy of the enterprise, its closure and sale of property.

Methods for measuring risk

There are several methods for measuring risk. The most common are statistical, expert and analytical methods for measuring risk. Use the statistical method is possible to study the statistics of losses that have occurred in similar types of business activity, set the frequency of occurrence of certain risk levels, and frequency - to predict the likelihood. So, if there is evidence of the relative losses calculated for the planned revenues from this type of business, then by dividing the number of cases in which took place this level of losses, the total number of cases examined, we find the frequency of this level of losses.

The expert method, or expert judgment, in relation to business risk can be realized by processing appraisal opinions experienced specialists. With the expert method, estimates are given of the probabilities of the occurrence of certain loss levels, by which it is then possible to determine the mean values ​​of expert estimates and, if desired, to construct a probability loss distribution curve with their help.

When choosing investment projects, it is important to know the extent of the relationship between risk and return. Suppose an enterprise specializes in the production of goods "A". At the same time, at the same enterprise, it is possible to arrange the production of the goods B or the B & quot ;. What to choose? Blue for the product A and the B depends on the same variables, and the demand for goods A and B is in negative dependence. This negative dependence makes the goods A and B ideal for diversification of production. Such diversification somewhat reduces the overall return on the enterprise, but reduces the risk of a sharp decrease in income.

Venture capital and venture capital

Entrepreneurship in a market economy is impossible without risk. If an entrepreneur does not take risks, he ultimately suffers bankruptcy. The existence of a risk factor is a strong incentive for businesses and businesses to save money and resources, which should force them to carefully analyze the profitability of projects, develop investment estimates, and hire relevant personnel. Innovations that are considered particularly risky, it is difficult to finance from generally accepted sources. To do this, there is venture capital. Business ventures are defined as venture, or venturing. Venture capital (from venture capital) represents money in the form of signed share capital and borrowed capital. This money should be used solely to finance new businesses and activities that are considered the most risky, and therefore, as mentioned earlier, these enterprises can not find financing under normal conditions. Venture capital forms a significant sector of the money market, including in its scope of activity an element of probability (the possibility of accomplishing an indefinite event). The probability of the venture is measured on a scale from 0.0 (event is impossible) to 1.0 (the event will exactly happen). The degree of probability is estimated based on the relative frequency with which an event occurred in the past, and then a rule is derived that allows foreseeing the situation.

Stock market

There are several special organizations that serve the venture capital sector. First of all, it is a stock market, which performs two main functions: first, it provides the primary market, or the new emission market, where the capital necessary for investments can be replenished by issuing new shares, bonds and other securities; secondly, it supports the secondary market, or the market for transactions with existing securities. The stock market occupies an important place in the financial system of each country and represents a mechanism for channeling savings into physical investments and investments in securities portfolios. The structure of the stock market as a maintenance service is a structure under the conditional name Three & quot ;. & quot ;. In the past, this structure was called "investors in industry". Today, it is a company that provides loans and equity for venture capital-related projects and other activities that require special financing, for example, initial financing of small but risky projects.

It should be noted that venture capital investors previously concentrated most of their activity on a small, recently opened business offering the latest technology. Now a significant part of their funds are sent to a less risky business.

Thus, venture capital is a capital of international importance that unites many companies that are mainly represented by the British Venture Capital Association.

Also We Can Offer!

Other services that we offer

If you don’t see the necessary subject, paper type, or topic in our list of available services and examples, don’t worry! We have a number of other academic disciplines to suit the needs of anyone who visits this website looking for help.

How to ...

We made your life easier with putting together a big number of articles and guidelines on how to plan and write different types of assignments (Essay, Research Paper, Dissertation etc)