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3 Exampes of a Risk-Reward Ratio John Spacey, updated on March 22, 2021
1. InvestingBased on a proprietary estimation, an investor guesses that the S&P 500 has equal chance of going up 20% or going down 5% in the next year. The investor sees the risk/reward of 1:4 as attractive and buys into the index.2. Product DevelopmentAn electronics company is considering launching a line of 3D printers. The development costs are significant and the company estimates there is an equal change of net income of $3 billion or a net loss of $2 billion from the product within the first 5 years. The company views the risk reward of 2:3 as unattractive and decides not to develop 3d printers.3. MarketingA luxury hotel is considering changing their pricing strategy to add a resort fee of $33 a day. They know that such fees are unpopular and the hotel has recently experienced declining ratings on popular travel review sites. They calculate that the price change will generate revenues of $1 million dollars but that there is a 50% chance of a customer backlash that will cost $12 million dollars in lost revenue due to a lower occupancy rate. The resulting risk/reward ratio is 6:1 meaning that the price increase is a risky proposition that's unlikely to payback.Types of Risk/Reward RatioThe risk-reward ratio is a simple mathematical equation: risk / reward that can be used to evaluate strategies, tactical actions and processes for their potential payback. For simplicity, the ratio is often expressed as gains and losses that are estimated to have equal probability. More accurate methods model risk as a risk matrix or probability distribution.RiskThis is the complete list of articles we have written about risk.If you enjoyed this page, please consider bookmarking Simplicable.
Business RisksA list of common business risks.Risk TreatmentThe four things that can be done about risk.Risk Management Effectiveness
A metric for measuring risk management.
Positive RiskThe potential that you'll achieve too much of a good thing.Dread Risk
Any risk that people have a strong aversion too.
Risk TakingThe definition of risk taking with examples.Risk ExamplesA list of risk examples by type.Risk Probability vs Risk ImpactThe two main factors in modeling a risk.Calculated RiskA definition of calculated risk with an example.Relative Risk
How to calculate relative risk with examples.
Economic TheoriesA list of economic theories that are particularly useful for business.Adverse Selection
The tendency for people at high risk to buy insurance.
Economic Advantage
A list of economic positions or capabilities that allow you to outperform in a particular industry.
Knowledge WorkA definition of knowledge work with examples.ProductionA definition of production with examples.Post Scarcity
An overview of post-scarcity.
Economic InfrastructureThe common types of economic infrastructure.Business Competition
The common types of business competition.
InefficiencyThe common types of inefficiency.Supply Examples
An overview of supply with common examples.
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