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Part 3: Conditiona l Probability and Bayes Formula SOA Exam P/ CAS Exam 1


Copyright © 2010 A&J Study Manual. This study material was purchased at www.anjstudymanual.com (Order
number [000000] on [June 1, 2000]) for the exclusive use of Exam P/1 Candidate. It is a violation of international
copyright law to resell, reproduce or otherwise distribute this product without the express written permission of
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Part 3. Conditional Probability and Bayes
Formula

This chapter discusses about:
1. Conditional Probability
2. Bayes Formula


3.1 Conditional Probability

Conditional probability refers to probability given that some other event has occurred. For
example, the probability that a 10-year old boy passes away within 5 years and the probability
that a 20-year old young man passes away within 5 years are not the same. This is because the
attained age is not the same. For the boy, 20 years of living has not occurred, but for the young
man, he has already attained 20 years old. The “events that has occurred” are not the same for
both persons.

Consider another example: in a class of 50 students, 20 are male students, 30 are female
students. Out of the 20 male students, 3 of them are smokers. Out of the 30 female students, 2
of them are smokers. The probability that a male student who smokes is chosen out from the
whole class is
3
50
, whereas the the probability that a male student who smokes is chosen out
from the 20 male students is
3
20
.

As we can see, the total number of possible event (the denominator) determines the probability.
The greater the total number of possible event, the smaller the probability is.

( )
( )
( )
( )
( )
|
n AB P AB
P A B
n A P A
= = , where
( ) | P A B can be interpreted as the probability that A occurs, given that B has already occured

Many students are confused between ( ) P AB and ( ) | P A B . The difference between these 2
lies at the time of the occurrence of B : AB implies that A and B happen at the same time,
while | A B implies that B has already occurred before A ; of course, | A B also implies that
both A and B happen, but the timing of occurrence are not the same.

Example 3.1
You are given that ( ) 0.3 P A = and ( ) 0.6 P B = . If A and B are independent of each other,
determine the probability that B occurs, given that A does not occur.

Solution 3.1
( )
( )
( )
( ) ( )
( )
( )
1
|
1
C
C
C
P A B P A P B
P B A P B
P A P A


= = = =

0.6.
Part 3: Conditiona l Probability and Bayes Formula SOA Exam P/ CAS Exam 1


Copyright © 2010 A&J Study Manual. This study material was purchased at www.anjstudymanual.com (Order
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the authors |

Example 3.2
You are given that ( ) 0.45 P A = , ( ) 0.3 P C = , ( ) 0.22 P BC = , and ( ) 0.32 P AC = . If A and B
are mutually exclusive, find ( ) | P B A C ∪ .

Solution 3.2
( )
( ) ( )
( )
( ) ( )
( ) ( ) ( )
0 0.22
|
0.45 0.3 0.32
P B A C P AB P BC
P B A C
P A C P A P C P AC
∩ ∪ +
+
∪ = = = =
∪ + − + −
0.5116.


Example 3.3
In urn A, there are 3 red balls and 5 blue balls. In urn B , there are 5 red balls, and n blue balls.
Determine n if the probability of drawing a blue ball from urn A is twice greater than the
probability of drawing a red ball from urn B .

Solution 3.3
Let A represents the event that a ball is to be drawn from urn A.
Let R represents the event that red ball is drawn.

As such,
( ) ( )
5 5
| 2 | 2 25 5 80
3 5 5
C C
P R A P R A n n
n
| |
= ⇒ = ⇒ + = ⇒ =
|
+ +
\ ¹
11.

Example 3.4
2 urns are selected at random. The probability that urn A is selected is 0.3.

In urn A, there are 3 white balls and 7 black balls. In the other urn, there are 2 while balls and 5
black balls.

A person is to select an urn, and draw a ball. The ball is then returned to the urn. This is
repeated for the 2
nd
time.

Determine the probability that white balls are drawn for both draws.

Solution 3.4
Let A represents the event that a ball is to be drawn from urn A.
Let W represents the event that white ball is drawn.

The first and second draws are independent of each other, since the result of the first draw does
not affect the 2
nd
draw. Hence, we need to find the probability that a white ball is drawn, and
square it to obtain the answer.

Since white ball can be drawn from urn A and other urn, we need to consider both urns:

( ) ( ) ( ) ( ) ( ) ( ) ( )
2 2
2
| |
C C C
P W P AW P A W P W A P A P W A P A

= + = +


( ) ( )
2
3 2
0.3 1 0.3
3 7 2 5
| | | |
= + − =
| |
+ +
\ ¹ \ ¹
0.0841
Part 5: Discrete Probability Distribution SOA Exam P/ CAS Exam 1


Copyright © 2010 A&J Study Manual. This study material was purchased at www.anjstudymanual.com (Order
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the authors |

Part 5. Discrete Probability Distribution

This chapter discusses about:
1. Uniform distribution
2. Binomial distribution
3. Poisson distribution
4. Negative binomial distribution
5. Hypergeometric distribution

Consider this illustration: You are a human resource manager, considering 2 fresh graduates
who have applied for an actuarial executive position in your company. Their GPAs are not yet
known because they have just taken their final exams yesterday. You are to hire one of them
based on their statistic exam mark that they took yesterday, given that one of them is from
Harvard University whereas another one is from XXX University (a university which is not in the
top 5000 world university list). No doubt, common sense tells you to recruit the Harvard
graduate, since the probability that Harvard graduate has higher exam mark is much higher.

Now, if you are given that the statistic exam mark of both students are in range between a and
9 a + , discretely and equally distributed, is the value of a the same for both students? The
answer is no. The Harvard graduate probably has higher value of a , say 85 a = , whereas for
XXX graduate, maybe the value of a is lower, say 65 a = . This variable a is known as the
parameter of the distribution of the statistic mark of the student.

Let us look at some commonly used discrete probability mass distribution with their properties.


5.1 Uniform Distribution

If a random variable N follows discrete uniform distribution, mathematically, such relationship is
represented by ( ) , N U a b ∼ , which means:
( ) ( ) { }
1
, , | , P N n a b a b
b a
= = ∈ ∈

ℤ ℤ ,
where a andb are the parameters of this distribution.

As you can see, every value of n between a andb are equally distributed at the probability of
1
b a −
, therefore it is known as uniform distribution. As such, the expected value of random
variable N is simply ( )
2
a b
E N
+
= ; the simple average of the boundaries. The variance of N is
( )
( )
2
12
b a
Var N

= .
For a random variable N following uniform distribution with parameter a andb ,
( )
2
a b
E N
+
= , ( )
( )
2
12
b a
Var N

=
.

Part 5: Discrete Probability Distribution SOA Exam P/ CAS Exam 1


Copyright © 2010 A&J Study Manual. This study material was purchased at www.anjstudymanual.com (Order
number [000000] on [June 1, 2000]) for the exclusive use of Exam P/1 Candidate. It is a violation of international
copyright law to resell, reproduce or otherwise distribute this product without the express written permission of
the authors |

Example 5.1
You are given that the annual claim frequency of an insurance company is uniformly distributed
between 101 and 150. Find:
1. ( ) P N n ≤ ;
2. ( ) E N ;
3. ( ) Var N ;
4. ( ) 123 P N < ;
5. ( ) 136| 120 P N N < > ;
6. ( ) | 135 140 E N N < ≤ ;
7. ( ) | 135 140 Var N N < ≤ .

Solution 5.1
1. ( )
1 1
, 101,102, 150
150 100 50
f n n = = =

… . Hence,

( )
101
1 100
, 101,102, 150
50 50
n
i
n
P N n n
=

≤ = = =

… .
2. ( )
150 100 250
125
2 2
E N
+
= = = .
3. ( )
( )
2
2
150 100
50
208.33
12 12
Var N

= = = .
4. ( ) ( )
122 101
123 122 0.42
50
P N P N

< = ≤ = = .
5. ( )
( )
( )
( ) ( )
( )
135 100 120 100
50 50
120 100
50
121 135
15 1
136| 120
1 120 30 2
1
P N
P N N
P N
− −

≤ ≤ −
< > = = = =
− ≤

.
6. If N is constrained between 136 and 140, this means that N is uniformly distributed from
136 to 140. Hence, the expected value is ( )
140 136
| 135 140 138
2
E N N
+
< ≤ = = .
7. If N is constrained between 136 and 140, this means that N is uniformly distributed from
136 to 140. Hence, the expected value is ( )
( )
2
140 136
4
| 135 140
12 3
Var N N

< ≤ = = .


Part 5: Discrete Probability Distribution SOA Exam P/ CAS Exam 1


Copyright © 2010 A&J Study Manual. This study material was purchased at www.anjstudymanual.com (Order
number [000000] on [June 1, 2000]) for the exclusive use of Exam P/1 Candidate. It is a violation of international
copyright law to resell, reproduce or otherwise distribute this product without the express written permission of
the authors |

Example 5.2
If you are given that the discrete random variable N is uniformly distributed from 1 to 100, derive
the moment-generating function of N .

Solution 5.2
( ) ( )
( )
( )
100
1
100
1
100
1
1
100
tN
tn
n
tn
n
tn
n
M t E e
e f n
f n e
e
=
=
=
=
=
=
=





You should be able to do the reverse: recognize what distribution a random variable follows
given the moment-generating function.
Author’s Biography SOA Exam P/ CAS Exam 1


Copyright © 2010 A&J Study Manual. This study material was purchased at www.anjstudymanual.com (Order
number [000000] on [June 1, 2000]) for the exclusive use of Exam P/1 Candidate. It is a violation of international
copyright law to resell, reproduce or otherwise distribute this product without the express written permission of
the authors |

Author’s Biography

Alvin Soh was born in Penang, Malaysia. He has been keen in sharing and helping his peers in
actuarial exams. His strong passion in mathematics and actuarial career is reflected in his fast
progress in actuarial exams. He has passed all the preliminary exams in the mere 1.5 years and
he is more than willing to share his study methods and experience to every actuarial student
striving to progress in exams. He has also passed an advanced level exam and is pursuing his
CERA and FSA in Finance and Enterprise Risk Management. He is now working as an actuarial
analyst in Prudential Financial Inc.

The following is the progress of his exams:

Exam Passed Sitting
P/1- Probability Spring 2007
FM/2- Financial Mathematics Fall 2007
MLC- Models for Life Contingencies Spring 2008
MFE/3F- Models for Financial Economics Fall 2008
C/4- Construction and Evaluation of Actuarial Models Fall 2008
AFE- Advanced Finance and Enterprise Risk Management Spring 2009

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