You have been asked to assess certain risks of an organization and quantify their potential impact on the organization’s profitability. As a result of your inquiry, you have determined that the firm is exposed to two primary risks. One is a commodity price risk, namely the cost of oil, which is a large component of the organization’s production costs. The second risk is sovereign risk because the organization maintains significant facilities in another country that is considering imposing new taxes on foreign-owned businesses.
You have further determined that there is a 25% chance that oil prices will increase, which would reduce profits by $25,000. However, there is a 25% chance that oil prices will fall significantly, which would increase profits by $50,000. There is also a 50% chance that oil prices will only fall slightly, improving profits by $5,000. With regard to the sovereign risk, there is a 50% chance that the country’s government will impose a new tax, which would reduce profits by $50,000, and a 50% chance that no change will be made to the tax code.
Quantitatively evaluate this data by calculating the expected impact, the standard deviation, and the coefficient of variation for each risk. What do these statistics tell you about the possible risks?