Exam P/1
1st Edition
Alvin Soh
Outline
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A) Combinatorial Analysis
B) Basic Probability and Set Theory
C) Conditional Probability and Bayes Formula
D) Discrete Random Variables
E) Discrete Probability Distribution
F) Continuous Random Variables
G) Continuous Probability Distribution
H) Jointly Distributed Random Variables with its Applications
I) Jensen Inequality and Chebyshev’s Inequality
J) Application of Probability in Risk Management
Basic Probabilities and Set Theory
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Distributive Law
Basic Probabilities and Set Theory
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( )
A B C AC BC =
( ) ( ) ( )
AB C AC BC =
Basic Probabilities and Set Theory
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De Morgan’s Law
Basic Probabilities and Set Theory
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1 1
C
n n
C
i i
i i
E E
= =
 
=

\ .
1 1
C
n n
C
i i
i i
E E
= =
 
=

\ .
Basic Probabilities and Set Theory
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Law of Total Probability
Basic Probabilities and Set Theory
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( ) ( ) ( ) ( )
Pr Pr Pr Pr A AB AC AD = + + +
( ) ( ) ( ) ( )
n A n AB n AC n AD = + + +
Conditional Probability and Bayes Formula
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Bayes Formula
Conditional Probability and Bayes Formula
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( )
( )
( )
( ) ( )
( ) ( )
( ) ( )
Pr Pr  Pr
Pr 
Pr
Pr  Pr Pr  Pr
C C
AB B A A
A B
B
B A A B A A
= =
+
Discrete Random Variables
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Characteristics of Probability Mass Function
Discrete Random Variables
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1. ( ) Pr( ) f x X x = =
2. ( ) 0, f x x > ¬ e
3.
( ) 1
x
f x
e
=
¯
Discrete Random Variables
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th
k
moment
Discrete Random Variables
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( )
( )
: ( ) 0 : ( ) 0
( ) Pr
k k k
x f x x f x
E X x f x x X x
> >
= = =
¯ ¯
Discrete Probability Distribution
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If X follows binomial distribution, find:
1. Probability Mass Function
2. Expected Value
3. Variance
Discrete Probability Distribution
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The distribution is commonly represented by
( )
~ Bin , X n p , with
( ) ( )
Pr 1
n x
x
n
X x p p
x
÷  
= = ÷

\ .
, where
0,1,..., x n = , n and p are parameters for this distribution.
( )
E X np =
( ) ( )
1 Var X np p = ÷
Continuous Random Variable
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Transformation of Random Variables
using
“CDF” Method
Continuous Random Variable
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( ) ( ) ( )
( )
( )
( )
1 1
Pr Pr Pr Y g X X g Y or X g Y
÷ ÷
< = < >
depending on the function,
g
Continuous Random Variable
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Transformation of Random Variables
using
“Inverse Transformation” Method
Continuous Random Variable
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If
( )
Y g X = ,
( )
'
0 g X > , x ¬ ethen the p.d.f of Y is
( ) ( ) ( ) ( )
'
Y X
f y f h y h y = , where
( ) ( )
1
h y g y
÷
=
Continuous Probability Distribution
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If X follows Exponential distribution, find:
1. Probability Density Function
2. Expected Value
3. Variance
4. MomentGenerating Function
Continuous Probability Distribution
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( )
1
, 0
0 , elsewhere
x
e x
f x
u
u
÷ ¦
> ¦
=
´
¦
¹
( )
0
1
1
x y x
F x e dy e
u u
u
÷ ÷
= = ÷
í
( )
E X u =
( )
2
Var X u =
( )
1
1
X
M t
t u
=
÷
Application of Probability in Risk Management
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Relationship between the expected payment and the expected
payment with deductible
Application of Probability in Risk Management
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( ) ( ) ( )
^ E X E X d E X d
+
= + ÷
whereby,
( ) ( )
0 0
^ ( ) ( )
d d
d
E X d xf x dx d f x dx S x dx
·
= + =
í í í
( ) ( ) ( )
( )
d d
E X d x d f x dx S x dx
· ·
+
÷ = ÷ =
í í
Application of Probability in Risk Management
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Coinsurance
Application of Probability in Risk Management
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( ) ( ) ( ) ( ) ( )
Payment 1 1 E E X E X o o = ÷ = ÷
Application of Probability in Risk Management
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