Upside risks

In this sense, it is fair to say that uncertainty not only affects projects at startup, when predictions are typically hard to make, but also during other phases, when changes are constantly required, when it is necessary to consider different alternatives and when massive cooperation and exchange of information occurs with other actors. A high level of uncertainty generates risks at all project stages, in terms of both upside risks (opportunities) and downside risks. 

Based on the risks and the scenario analyses (see reward section), project teams should elaborate on the upside and downside potential of the project. This includes answers to questions such as, what would happen if the technology were available sooner than expected or what would be the impact if important factors did not develop as expected This also includes outlining an exit strategy (for example, to sell the patents to the competitor or license the technology). 

Share the cost and risk of clinical trials—and, of course, lose most of the potential upside—making sure that they license the product of their preclinical research to a company very experienced in the therapeutic area or clinical field. 

For each of the risks we must determine the impact of our assumptions being incorrect. The most common method to determine this is to perform a sensitivity analysis. To do this, each risk is examined and a reasonable upside and downside are determined and the economic analyses are recalculated. 

Such life-and-death questions pondered from afar suddenly cut a lot closer to the bone in 1979, when Peter was diagnosed with testicular cancer. There was nothing academic about listening to his divorced parents argue over which doctor they should trust with their son s life—the one who advocated a series of major, painful surgeries, or the other who would rely primarily on a difficult course of chemotherapy. Each treatment had its own risks, upside, and downside. There were no guarantees just terrifying discussions of mortality rates and survival rates. And it was Peter who had to make the call in the end. He was fifteen years old. 

All widely used measures of risk are related to the downside portion of the risk curve. In striving to minimize risk at low expectations, they rarely look at what happens on the upside. In other words, a risk averse decision maker will prefer curve 2 (Figure 12.8), while a risk taker will prefer curve 3. In reality, no decision maker is completely risk averse or completely risk taker. Therefore, some compromise like the one offered by curve 4 needs to be identified. Thus, some objective measure that will help identify this compromise is needed. If such a measure is constructed, the evaluation can be automated so that a decision maker does not have to consider and compare a large number of curves visually. Aseeri etal. (2004) discussed some measures and proposed others such as ... 

Opportunity value (or upside potential), which is defined the same way as VaR but on the upside. OV and VaR are illustrated in Figure 12.10 where two projects are compared, one with expected profit of 3 (arbitrary units) and the other of 3.4. The former has a VaR of 0.75, while the latter has a VaR of 1.75. Conversely, the upside potential of these two projects is 0.75 and 3.075, respectively. Considering a reduction in VaR without looking at the change in OV can lead to solutions that are too risk averse. 

By construction, the ratio cannot be smaller than 1, but the closer this ratio is to 1, the better is the compromise between upside and downside profit. Note also that this is only true if the second curve is minimizing risk in the downside region. If risk on the upside is to be minimized, then the relation is reversed (i.e. 0 Area is below the intersection and R Area is above it). 

As noted, a bond may contain an embedded option which permits the issuer to call or retire all or part of the issue before the maturity date. The bondholder, in effect, is the writer of the call option. From the bondholder s perspective, there are three disadvantages of the embedded call option. First, relative to bond that is option-free, the call option introduces uncertainty into the cash flow pattern. Second, since the issuer is more likely to call the bond when interest rates have fallen, if the bond is called, then the bondholder must reinvest the proceeds received at the lower interest rates. Third, a callable bond s upside potential is reduced because the bond price will not rise above the price at which the issuer can call the bond. Collectively, these three disadvantages are referred to as call risk. MBS and ABS that are securitized by loans where the borrower has the option to prepay are exposed to similar risks. This is called prepayment risk, which is discussed in Chapter 11. 

It can be seen from Exhibit 2.3 that bonds bear a smaller upside potential compared to stocks, for example, bond price increases after an upbeat earnings report of a company are usually smaller than share price advances. Shareholders also risk total loss but profit from theoretically unlimited increases in the company s value. The next section... 

Options are unique among hedging instruments in enabling banks and corporations to profit from upside market moves while covering their risk exposures. The contracts also have special characteristics that set them apart from other classes of derivatives. Because they confer the r ht to conduct a transaction without imposing an obligation to do so, they need be exercised only if the protection they offer is required. Options thus function more like insurance policies than like pure hedging instruments. The option price is in effect an insurance premium paid for peace of mind. 

Like caps, floors are series of individual contracts. These are called floorlets, and they function essentially as put options on interest rates. Lenders may buy floors to limit their income losses should interest rates fall. A long call cap position combined with a short floor position is a collar, so called because it bounds the interest rate payable on the upside at the cap level and on the downside at the floor level. Zero-cost collars, in which the cap and floor premiums are identical, are very popular with corporations seeking to mantle their interest rate risk. 

Any Rooting Interest Technique, flipped upside down, can make a character unlikable and make us unwilling to identify with that character. For instance, it s a Rooting Interest Technique to have a character risk sacrificing himself for another person who s in danger. Flip this upside down, and it makes the person unlikable. 

Upside-down contingencies that reward at-risk behavior or pxmish safe behavior. 

To protect against the upside demand risk, the buyer may buy an option to purchase the needed quantity of the item at an agreed upon price, which is exercised by the buyer at some future date when demand is high. The option price is determined by the stock market based on the extent of market volatility. 

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