Chapter 1 Tutorials

Question 1
A certain type of cancer is known to in 2 percent of the population of the males in their fifties. A
test for the disease has been is advertised by a pharmaceutical company to have %3 of false
negative and %1 of false positive.
1. Compute the probability that you have cancer if you are tested positive.
2. To make sure that you really have cancer an invasive and expensive surgery is needed. Your
health insurance company is not willing to pay for this unless the pharmaceutical company
improves its test in such way that that at least %90 of people who are tested positive actually
have the disease. How low should be the rate of false positive for the test to reach this goal?
(Assume that the rate of false negative remains the same).

Question 2
To do a certain commuting travel in the city of B., the probability to be delayed more than half
an hour is 0.57 if you travel by car, 0.28 if you take the bus (which can use an HOV traffic lane),
and 0.05 if you take a commuter train. Company Green wishes to encourages his employees to
use public transportation as well as minimize lost hours and so it provides a financial incentive to
his employees to use bus or train. Bob is late this morning, his supervisor would like to find out
how likely it is that Bob actually did not use his car. To do this assign prior probabilities that Bob
takes his car, bus, or train and use then Bayes formula. Discuss how you should assign prior
probabilities.

Question 3
The 95% confidence interval of the sample mean of employee age for a major corporation is 19
years to 44 years based on a z-statistic. The population of employees is more than 5000 and the
sample size of this test is 100. Assuming the population is normally distributed, what is the
standard error of mean employee?

Question 4

There are two urns containing colored balls. The first urn contains 50 red balls and 50 blue balls.
The second urn contains 30 red balls and 70 blue balls. One of the two urns is randomly chosen
(both urns have probability of being chosen) and then a ball is drawn at random from one of the
two urns. If a red ball is drawn, what is the probability that it comes from the first urn?

Solution

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In probabilistic terms, what we know about this problem can be formalized as follows:

The unconditional probability of drawing a red ball can be derived using

the law of total probability:

Using Bayes' rule we obtain:

Question 5

An economics consulting firm has created a model to predict recessions. The model predicts a
recession with probability 80% when a recession is indeed coming and with probability 10%
when no recession is coming. The unconditional probability of falling into a recession is 20%. If
the model predicts a recession, what is the probability that a recession will indeed come?

Solution

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What we know about this problem can be formalized as follows:

The unconditional probability

of predicting a recession can be derived using the law of total probability:

Using Bayes' rule

we obtain:

Question 6

Alice has two coins in her pocket, a fair coin (head on one side and tail on the other side) and a
two-headed coin. She picks one at random from her pocket, tosses it and obtains head. What is
the probability that she flipped the fair coin?

Solution

What we know about this problem can be formalized as follows:

The unconditional probability of obtaining head can be derived using the law of total probability:

3
 Using

Bayes' rule we obtain:

Question 7

Calculate the mean absolute deviation (MAD = 6.63) and the sample variance (75.98).

Mont Return Deviation Squared Deviation Absolute Return Deviation

h Return (Ri %) (Ri - Ŕ ) (Ri - Ŕ ) 2 ¿
Jan -3.7
Feb -7.0
mar -10.4
Apr -0.8
May 11.4
Jun -0.9
Jul 2.0
Aug -9.7
Sep -13.9
Oct 15.6
Nov -5.9
Dec 1.7

Question 8

The table below contains monthly total returns (in %) on the S&P 500 from January 1991 to December
1991.

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Jan-91 4.42
Feb-91 7.16
Mar-91 2.38
Apr-91 0.28
May-91 4.28
Jun-91 -4.57
Jul-91 4.68
Aug-91 2.35
Sep-91 -1.64
Oct-91 1.34
Nov-91 -4.04
Dec-91 11.43

1. Create a frequency distribution with four equally spaced intervals.

2. Construct a histogram
3. Calculate the sample mean return and the geometric mean return.
4. Calculate the median
5. Calculate the standard deviation and mean absolute deviation
6. Calculate the skewness and the excess kurtosis

n
Formula for sample skewness Sk =n ∑ ¿ ¿ ¿
i=1

Formula for excess kurtosis

n
n ( n+ 1 )
k= ∑ ¿ ¿ ¿¿
( n−1 ) (n−2)(n−3) i=1