You have further determined that there is a 25% chance that oil prices will incr

Question

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?

Explanation / Answer

For change in Oil price the table is given below:

For the new tax regime, the table is as shoen below

State Probability ( P) Returns ( R ) ( R - E ( R ) ( R - E ( R ))72 [( R - E ( R ))^2]*p Will rise 0.25 -25000 -33750 1139062500 284765625 Will Fall 0.25 50000 41250 1701562500 425390625 Fall slightly 0.5 5000 -3750 14062500 7031250 Expected Return E ( R ) 8750 0.25*(-25000)+0.25*50000+0.5*5000 Variance 717187500 Sum of the last column Std.deviation 26,780.35 Sqaure root of variance

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