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QAM I Midterm Time = 120 minutes Total Marks = 30

Instructions:

1. This is closed book, open notes exam.

2. Laptops are not allowed.
3. You are allowed to carry scientific calculators.
4. You may use the standard normal distribution table provided along with this
question paper.
5. Please show all calculations / reasoning in detail.
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Question 1: (Total Marks = 9)

IMM automotive manufactures anti-lock braking systems (ABS) for automobiles. This is a
computer controlled braking system that is designed to improve vehicle’s stopping capability in
case of emergency. Recently IMM automotive got a contract to supply ABS to a major automobile
manufacturer in Europe. The detailed design and software for ABS is provided by IMM
headquarters in USA. The manufacturing is outsourced to three different companies in China,
Brazil and India. Each country supplies the ABS in kits to an assembly unit in Frankfurt
(Germany). The kit contains the ABS in modularized form (broken into few modules). The
Frankfurt facility assembles the different modules, attaches labels and markets the product in
Europe.
The country of manufacture is not printed on the kits, but on digging deep it is found that the
percentage of defectives in ABS kits given that they are made in the factories in China is 20
percent. The corresponding percentages for kits manufactured in India and Brazil are 15 percent
and 10 percent respectively. It is understood that the defects arise only from the manufacturers in
China, India and Brazil. There are no defects in assembling at the facility in Frankfurt. China
supplies 20 percent of ABS kits, India supplies 30 percent and Brazil supplies 50 percent.

a. What is the joint probability that an ABS kit selected randomly is made in China and is
defective? (2marks)
b. If one ABS kit is selected at random (before being assembled in Frankfurt), what is the
probability that it is defective? (2 marks)
c. The average cost of ABS kit from China is 700 Euros, that from India is 650 Euros and
that from Brazil is 600 Euros. If the cost of assembly at Frankfurt is 100 Euros, what is
the total average cost of a randomly selected ABS kit? (2 marks)
d. What is the variance in total cost of a randomly selected ABS kit? (2 marks)
e. Fixing a defective ABS kit will cost 80 Euros. What is the average amount that IMM
spends to repair a randomly selected ABS kit? (1 mark)
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Question 2: (Total Marks = 5)

In addition to the information given in Question 1, suppose that each batch is inspected thoroughly
at Frankfurt before being sent for assembly. Each batch contains 20 ABS kits. A batch is rejected
or passed depending on the number of defects detected. The facility at Frankfurt has high
standards. A maximum of 2 defects are allowed in a batch.
a. What is the probability of a randomly selected batch passing inspection? You may use
relevant data from Question 1. (3 marks)
b. Continuing from 2(a). A checking inspector starts his job at 08:00 AM in the morning.
What is the probability that the fourth batch inspected by him is the first batch to be passed
(since 08:00 AM in the morning)? (1 mark)
c. Continuing from 2(b). On average how many batches the inspector should inspect to pass
the first batch of the morning? (1 mark)

Question 3: (Total Marks = 5)

The firm that manufactures ABS units in India for IMM automotive is based in Chennai. It has
two manufacturing units. One manufacturing unit is located in Guindy and another in Taramani.
The monthly profit earned by both manufacturing units are random. Since the two units share some
common resources and processes the profit earned by each are not independent. It is estimated that
the correlation between the two profits is 0.4. Also the monthly profit earned by Guindy unit is
normally distributed with mean 16.5 (in thousands) and standard deviation 1.5 (in thousands).
Further the Taramani unit earns monthly profit which is normally distributed with mean 17 (in
thousands) and standard deviation 2 (in thousands).
What is the probability that the monthly profit of Guindy unit exceeds that of the Taramani unit?
Hint: Difference of two normally distributed random variable is also normal.

Question 4: (Total Marks = 5)

A portfolio consists of two stocks X and Y. Each stock has three possible returns. Stock X can
give returns -5%, 1% and 5%. Stock Y gives returns -3%, 2%, 3%. The joint distribution table for
the return on the two stocks is as follows:
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-5% 1% 5%
-3% 0.18 0.12 0.10
2% 0.10 0.15 0.05
3% 0.05 0.10 0.15

(a) Are the returns from the two stocks X and Y correlated? What is the nature and strength
of this correlation (provided it exists)? (3 marks)
(b) Are the returns from the two stocks X and Y independent? (2 marks)

Question 5: (Total Marks = 3)

Insurance claim from fire insurance issued by a company is modeled to have NORMAL
distribution. Only 1% of such claims exceed Rs. 10 lakhs, while 2.5% of such claims are for less
than Rs. 4 lakhs. What percentage of claims from this fire insurance policy is for an amount
between Rs 5 lakhs and 8 lakhs?

Question 6: (Total Marks = 3)

The returns from investing in different stocks depends on the state of the economy of the country.
The state of the economy can be categorized as follows: Very Poor Growth; Poor Growth; Medium
Growth; High Growth and Very High Growth. The probabilities of the economy being in these 5
states in the next 6 months and the corresponding returns from 3 stocks are given in the table
below:

State of Probabilities % of returns % of returns % of returns

Economy Stock A Stock B Stock C

Very Poor 0.3 10 40 50

Growth

Poor Growth 0.3 20 -20 0

Medium Growth 0.2 -10 10 -20

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High Growth 0.1 -10 20 -70

Very High 0.1 30 -20 60

Growth

As an investor out of the 3 different stocks which stock would you invest in? Why?