CALCUTTA BUSINESS SCHOOL

PGDM I; RISK MANAGEMENT

SUGGESTED QUESTIONS
1. Explain the nature of exponential utility function of x which is a random variable pay-off.
Accordingly, discuss the concepts of risk aversion, risk neutral and positive preference of
risk. Derive the risk-adjusted value of a random variable which is distributed uniformly in
the domain a x b, where a and b are positive.
2. Firm A is engaged in a bidding competition with one other Firm B to obtain a large
government contract. The contract is to be awarded solely on the basis of lowest sealed
bid submitted. The Firm A wants to bid Rs. X without knowing Bs bid of Rs. Based on
the past behavior in similar situations, the probability of Bs bid Rs. Y is 0.2 for all values
of Y = 2.9, 3.0, 3.1, 3.2, and 3.3 crores (0 probability for other values of Y). The cost of
performing the contract is Rs. 3.0 crores. Firm As bid of Rs. X can be any value; but is
best restricted to the same set of possible values of Y (each one paise lower to resolve ties
in As favor). What should be the optimum value of X when As risk parameter r = 10?
3. Consider two large independent risky projects, each with normally distributed outcome,
have the following particulars:
Relevant Data Items
Estimated Cost (Crores)
Mean Return (Crores)
Variance Around Mean

Project 1
10.5
13.5
25.0

Project 2
20.5
25.5
36.0

A contractor, who is perceived to have a risk factor r = 0.5, wants to participate in both
the projects simultaneously. What are his optimal participation shares? Would these
shares change when the projects are dependent on one another with correlation coefficient
= 0.7? If so, what are the new optimal values? What it = -0.7? Comment on all the
situations.
4. Suppose an investor has an amount Rs. C of capital to invest in two common stock
investment opportunities that are not independent in a probability sense. The investment
will be held for 1 year. The unit return on investment in stock i is (1+Xi), where Xi is a
random variable. Let c1 and c2 be the amounts to be invested in stocks 1 and 2
respectively. If the initial capital is not all invested, the remainder is deposited in a bank
for one year and will return 1+I per Re, where I is the riskless interest rate. Suppose, X1
and X2 are jointly normally distributed with means 1 and 2 respectively; standard
deviations 1 and 2 respectively and their correlation coefficient is . Formulate the
problem of selection of the amounts c1 and c2 to be selected optimally.
Formulate the problem of finding values of c1 and c2 that maximize the risk-adjusted
value of total expected return over total return due to risk-free interest rate I subject to the
condition that total of c1+c2 cannot exceed C. Derive the general rules first and using the
same to find the numerical solution for the following situation:
Stock 1.
Stock 2.
Interest Rate
Risk Factor
Initial Capital
Correlation Coefficient
Comment on the numerical solution.

1 = 0.068, 1 = 0.03
2 = 0.056, 2 = 0.02
I =0.04
r = 0.01
C = Rs. 5000
= 0, +0.5, -0.5

5. A small project consisting of 7 activities, whose time estimates are listed in the table
below. Activities are identified by their beginning (i) and ending (j) node numbers.
Activit
y

Past Experiences on Activity Durations (weeks)

(i -j)

Optimistic Time (a)

Most Likely Time (m)

Pessimistic Time (b)

1-2
1-3
1-4
2-5
3-5
4-6
5-6

1
1
2
1
2
2
3

1
4
2
1
5
5
6

7
7
8
1
14
8
15

(a) Construct an AOA network diagram for the project.

(b) Find the expected duration and variance of each activity. What is the expected project
duration T?
(c) Calculate the variance and standard deviation of the expected project duration. What
is the probability that the project will be completed in time Tc when
(i)
Tc = T- 1.
(ii)
Tc = T+1.
(d) Assuming
Profit = Rs. 5 crore when Tc = T-1
Profit = Rs. 4 crore when Tc = T
profit = Rs. 3.5 crore when Tc = T+1
profit = Rs. -10 crore when Tc > T+1
Find the risk adjusted value of total expected profit when the risk factor r = 0.5.