Q1. Solve following matrix operations.

For (ii) to (iv), check whether the answers for both

operations are same.

1 2 3 2 4 6
(i) 2× =
4 5 6 8 10 12

(2 + 3) × 1 2 3 5 10 15
(ii) = and
4 5 6 20 25 30

1 2 3 1 2 3 5 10 15
2× +3× =
4 5 6 4 5 6 20 25 30
2 3
1 2 3 18 20
(iii) 2× × 2 2 = and
4 5 6 48 56
1 1
2 3
1 2 3 18 20
2× × 2 2 =
4 5 6 48 56
1 1
3 3 2 1 18 18 2 1 3 3 9 9
(iv) × = and × =
3 3 4 5 18 18 4 5 3 3 27 27

Q2. We have a random variable, X. Using the variable, we construct a new variable Y, defined
below: Y = 3X+5. Calculate the mean and variance of Y in terms of X.

(i) E(Y) = 3 E(X)+5

(ii) Var(Y) = 9 Var(X)

Q3. We have two random variables, X and Y. Using the two random variables, we construct
new variables, A and B as following:

A=5X+2
B=X+Y

Solve the problems below in terms of X, Y, µx=E(X), and µy=E(Y).

(i) E(A+B) = E(5X+2 + X + Y) = E( 6X+Y+2)

= 6 E(X) +E(Y) + 2
= 6µx + µy + 2
(ii) Cov(A,B) = Cov(5X + 2, X + Y)
= E[(5X + 2) − E(5X + 2)] [X + Y − E (X + Y)]
= E [5X − 5E(X)][(X – E(X))+(Y − E(Y))]
= 5E[(X – E(X))2 + (X – E(X))(Y – E(Y))]
= 5E(X – E(X))2 + 5E(X – E(X))(Y – E(Y))
= 5Var(X) + 5Cov(X,Y)

(iii) Var(A+B) = Var(A) + Var(B) + 2Cov(A,B)

= 25Var(X) + Var(X) + Var(Y) +2Cov(X,Y) + 2Cov(A,B)
= 26Var(X) + Var(Y) +2Cov(X,Y) +2*(5Var(X) + 5Cov(X,Y))
 =36Var(X) + Var(Y) + 12Cov(X,Y)

Q4. The following table shows the monthly returns of asset X and Y.

Asset X Asset Y
0.1 0.2
-0.2 -0.11
0.16 -0.02
0.07 0.3
-0.15 -0.01

(i) Calculate the expected return and variances of asset X and Y.

Asset X Asset Y
Expected returns -0.40% 7.20%
Variances 0.0257 0.0292

(ii) Calculate the covariance between asset X and Y.

Cov(X,Y) = 0.0157

Q5. Daniel argues that some mutual funds consistently outperform the market (that is, the
return of the mutual fund is higher than the return of S&P 500). He found that there are 5,000
mutual funds reported in The Wall Street Journal on February 18. His friend Bill believes that
performance relative to the market is driven by luck, we mean that each fund has a 50–50
chance of outperforming the market in any year and that performance is independent from year
to year. With the investment period of 10-year, Bill wants to calculate the probability that any
particular fund outperforms the market in all 10 years.

(i) Define a random variable in the question. Is it continuous or discrete?

We define the performance of a particular fund relative to the market as a

random variable, Xi.

Xit = 1 if a fund i outperforms the market in a particular year t

Xit = 0 if a fund i underperforms or performs as the market in a particular year t
P(Xit =1) = 0.5 and P(Xit =0) = 0.5
As our random variable X has only dichotomous outcomes (0 and 1), it is a
discrete random variable. Note that the sum of the probabilities is equal to one,
which means this is well defined.

(ii) Calculate the probability.

The quantity we are interested in is the probability that any particular fund outperforms the
market in all 10 years.

This quantity can be written as:

P(Xi1=1, Xi2=1, Xi3=1, Xi4=1, Xi5=1, Xi6=1, Xi7=1, Xi8=1, Xi9=1, Xi10=1).

The important assumption given in the question is that performance is independent from year
to year. This means that the performance of a fund this year does not affect the performance of
next year. Hence, the random variables, Xit, in the above equation are independent. This enable
us to rewrite the above equation as:

P(Xi1=1)*P(Xi2=1)*P(Xi3=)1*P(Xi4=1)*P(Xi5=1)*P(Xi6=1)*P(Xi7=1)*P(Xi8=1)*P(Xi9=1)*P(
Xi10=1).

We can calculate the above quantity as:

( = 1) = (0.5) = 1/1024.