- Let's talk about risk, uncertainty, variability.
- Okay, I'm scared, but let's go ahead and talk about it.
- Let's say that you were running an airline.
What risks would you face?
In other words, what uncertainties
would you have to consider as part of your business plans?
- Here are some of the risks.
Uncertain passenger demand, based on ebbs and flows
in the global economy, and also ebbs and flows
in concerns about security and safety.
Uncertainty about what my competitors might do.
Will they merge?
Will they cut prices to compete with me
on my most important routes?
Fuel prices, employee strikes, technology outages.
Yeah, there are lots of risks
associated with running an airline.
- So let's say that you were planning
to gather up all of your life's savings,
and use it to start your own airline.
- (chuckles) Okay, yeah,
but it'd have to be a pretty small airline.
How about if we combine our life's savings, yours and mine?
Now with a massive influx of cash from your savings,
we'd have enough for a pretty fair sized airline.
- Okay, fine, you and I use our life's savings
to start an airline.
We know about all of the risks that you just listed.
So what kind of return would we expect on our investment?
- Okay, so now, return, what do you mean by that?
- Well, if we just took our savings down to the local bank
and put it into a savings account,
we'd get a return of, say, point one percent.
If, instead, we used the savings to start our airline,
would we expect a higher return or a lower return?
- A higher return, much higher!
- Why?
- Well, because of the risks.
The savings account is pretty much risk free.
But the investment in the airline, very uncertain.
I'm going to expect a much higher return to induce me
into such a risky investment.
- Exactly!
There is a connection between risk and return.
Let's talk about that connection.