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Life is full of uncertainty. It would be wonderful if we could accurately predict tomorrow’s weather (or the questions on next week’s exam!). Thankfully, we can take measures to protect ourselves from uncertainty, such as carrying an umbrella (or studying), thus mitigating the risk involved.
In this chapter, we will study how risk can be accounted for in financial decision making. We will discuss some measures of risk and how we can control our exposure to it. The study of finance is, at its core, about the tradeoff between accepting a degree of risk for a potentially higher return.