Risk Math Example 1
Follow the full solution, then compare it with the other examples linked below.
Example 1
mediumA business faces two possible disasters: (A) equipment failure β probability 0.10, cost \50,000; (B) data breach β probability 0.02, cost \500,000. Calculate the expected loss from each and determine which poses greater financial risk.
Solution
- 1 Expected loss A: E_A = P(A) \times \text{cost} = 0.10 \times 50000 = \5,000$
- 2 Expected loss B: E_B = P(B) \times \text{cost} = 0.02 \times 500000 = \10,000$
- 3 Compare: E_B = \10,000 > E_A = \ β data breach poses greater expected financial risk
- 4 Interpretation: despite being less probable, the data breach's high cost makes it the bigger financial threat
Answer
Expected loss: Equipment = \5,000; Data breach = \10,000. Data breach is the greater financial risk.
Expected loss = Probability Γ Magnitude. A rare but catastrophic event can have greater expected loss than a common but minor one. Risk management must consider both frequency and severity of potential losses.
About Risk
Risk is the possibility of loss or negative outcome, quantified by combining the probability of the event with the severity of its impact: Expected Loss = P(loss) times amount of loss.
Learn more about Risk βMore Risk Examples
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