Financial Management: Core Concepts, Third Edition

8.2 Risk (Certainty and Uncertainty)

We can define risk in terms of uncertainty. Certainty is knowing what is going to happen before it happens. Uncertainty is the absence of knowledge of the actual outcome of an event before it happens. For example, in a horse race with ten horses in the field, we cannot know the winner for certain before the race takes place. Although one horse might be a heavy favorite, there is the real possibility that another horse could pull an upset and win the race. There are ten potential winners for the race, and we cannot predict for certain which horse will win. When there is more than one potential outcome of an event, there is uncertainty, and if we pick the wrong horse, we lose our bet. You may wonder if gambling ...