Salvatore's Chapter 14:

a. Discussion Questions: 12 and 15. b. Problems: spreadsheet problems 1 and 2.

12. What is the rationale behind the minimax regret rule? What are some less formal and precise methods of dealing with uncertainty? When are these useful?

The rationale is to reduce the threat associated with business decisions and minimize the mistakes from those decisions. The miscalculations associated with each decision is calculated by subtracting the payoff from the maximum payoff under the same state of nature. The decision maker then determines the strategy with the minimum of these maximum regrets under any possible state of nature. Some of the more informal and less precise methods of dealing with uncertainty include the following: • The acquisition of additional information • Referral to authorities such as the Internal Revenue Service and the Securities and Exchange Commission to remove any uncertainty regarding their specific expertise • Attempting to control the business environment for their respective firms using things such as patents and copyrights. • Diversifying the product line as well as security holdings within the company’s portfolio
15. How does the adverse selection problem arise in the credit-card market? How do credit-card companies reduce the adverse selection problem that they face? To what complaint does this give rise? Adverse selection/negative selection pertains to a market in which unwanted consequences occur from asymmetric information between sellers and buyers. Bad products and services stem from this kind of system and unfortunately these products are most likely used by those with bad credit history. Credit-card companies reduce the adverse selection issues by using third party underwriting. Interest rates can also be raised to reduce the risk of borrowers