Risk and Reward/Predicting Cash-Flow: Investors think as much about risk as they do reward. Most people tie their investments to resources, expecting them to grow, and with it, their own rewards. Where rewards are expressed in percentage growth, risks are harder to characterize. Guessing a company’s future cash-flow involves looking at past revenue, you then make reasonable assumptions based on how the new product will fair or how their rivals will be purchased. A dollar today is worth more than a dollar in a year’s time so if I buy a one-year bill that promises 5% interest, you will have $1.05 next year. Whereas a dollar next year is just a dollar. If I want a dollar next year, I could buy 95.2% worth and have the 4.8% to spend. This works with the federal government but a company or angel investor can expect to demand a higher return to compensate for the risk of their capital. The next step is to determine what the return on investment would be for these investors. Opportunity costs; it’s better to invest in an apartment than a stock. Apartments are illiquid, and it is much easier to trade in and out of other investments. Savings have low returns because they are highly liquid. If you tied up your money for a long period, it would bring about higher returns. Imagine a house party where you are going to meet the person of your life. If you didn’t go to that house party, then you would have missed out and the risk is enormous. Risk is actually not just the possibility of a bad thing happening, but of something good not happening.
Mergers and Acquisitions: Company A announces a merger with Company B, it offers a price x, for Company B which is about Company B’s current stock market valuation. The arbitrageur asks himself, is the likelihood that this deal will actually go through? Will the shareholders of Company B accept it? Will there be account fraud of Company B? What if the CEO of Company A dies? The stock prices of the merging companies move around more than usual as investors weigh up the probability of the merger’s taking place. For risk arbitrageur, the risk of losing $100,000 is .1% and the risk of losing $500 is 20%. They spend an inordinate amount of time thinking about the 20% chance ruining a day instead of the .1% chance of running a career. Everywhere in life there are small risks of disaster that you would think of as an arbitrator: chances of the babysitter turning to be a kidnapper; and the costs would be infinite.
Porter’s Theory: Michael Porter believes that competition is the engine of productivity, growth and every business, town or country should be seeking out a competitive advantage. He’s not interested in cost and willingness to pay…
Private/Public Sectors: The relationship between business and government. Government gets its tax revenue from businesses, don’t ever forget that fact. Many believe that business does not need government whatsoever. MBAs are taught to believe that business is the most important institution in society.