Slide 1
CHAPTER THIRTEEN
RISK ANALYSIS
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Slide 2
Types of Risk
• Business- uncertainty of renting space
• Financial- effect of leverage on return
• Liquidity- ability to sell quickly
without loss
• Inflation- effect of unexpected inflation
on return
• Interest Rate- effect of change in
interest rates on return
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Slide 3
Types of Risk Continued
• Management- effect of management on
returns
• Legislative- effect of national, state, and
local laws and regulations on returns
• Environmental- effect of environmental
hazards on return
• Other? (physical, weather, plagues,
terrorism)
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Slide 4
Risk Preferences
• Risk- averse behavior
• Risk- neutral behavior
• Risk- loving behavior
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Slide 5
Measuring Project- Specific Risk
State of the
Economy
Deep Recession
Probability
Return
0.05
Mild Recession
0.20
Average
Economy
Mild Boom
0.50
3.0%
5.5%
7.0%
0.20
8.5%
Strong Boom
0.05
11.0%
Expected Return
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7.0%
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Slide 6
Risk Management
• Three primary tools may be employed
by investors to minimize their expose
to risk:
– Avoid risky projects
– Use insurance and hedging
– diversification
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Slide 7
Portfolio Risk
• Diversifiable Risk: (unsystematic risk)
can be eliminated by holding assets
that are less than perfectly correlated.
• Nondiversifiable Risk: (systematic, or
market risk) is the risk remaining in a
fully- diversified portfolio.
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Slide 8
Optimal Portfolio Decisions
• Investors base their investment
decisions on its contribution to the
portfolio’s risk and return.
• Efficient investments increase the
portfolio’s expected return without
adding risk.
• Efficient investments decrease the
portfolio’s risk for a given expected
return.
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Slide 9
Accounting for Risk
• The investor’s required rate of return is
(E(Rj))
• E(Rj)= Rf+ RPj
– Where Rf is the risk free rate and RPj is a
premium for bearing risk.
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Slide 10
Accounting for Risk
• Asset pricing model to estimate risk
• Sensitivity analysis
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Slide 11
Quantifying Risk
• Sensitivity analysis- what if…
– Market rents lower
– Vacancy rates higher, etc,
– How sensitive is return to change in an
assumption
• Scenarios
– Pessimistic, most likely, optimistic
– E.g., rents lower and vacancy higher for
pessimistic scenario
– Calculate return or other measure for each
scenario
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