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Exam P

Written & Presented by Matt Hassett, ASA, PhD

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Remember:

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This is a review seminar. It assumes that you have already studied probability. This is an actuarial exam seminar. We will focus more on problem solving than proofs. This is an eight hour seminar. You may want to study more material.

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Copyright ACTEX 2006

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Other Study Materials: Probability for Risk Management (Text and Solutions manual) Matt Hassett & Donald Stewart ACTEX Publications ACTEX Study Guide (SOA Exam P/CAS Exam 1) Sam Broverman ACTEX Publications

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Exam Strategy:

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Copyright ACTEX 2006

Maximize the number of questions answered correctly. Do the easier problems first.

**Don’t spend too much time on one question.
**

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Points to Remember: A TV screen holds less content than a blackboard; use your handout pages for overview. Algebra and calculus skills are assumed and required. Expect “multiple skill problems”. Calculators?

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Probability Rules:

Negation Rule:

P(E′) = P(~ E) = 1- P(E)

Disjunction Rule:

P(A ∪ B) = P(A) + P(B) - P(A ∩ B)

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Copyright ACTEX 2006

05 (B) 0.12 (C) 0.Probability Rules.35 8 Copyright ACTEX 2006 . Determine the probability that a visit to a PCP’s office results in both lab work and referral to a specialist.25 (E) 0. 30% are referred to specialists and 40% require lab work. cont. P(A∪B) = P(A) + P(B) 7 Exercise: The probability that a visit to a primary care physician’s (PCP) office results in neither lab work nor referral to a specialist is 35% .18 (D) 0. Of those coming to a PCP’s office.: Definition: Two events A and B are called mutually exclusive if A ∩ B = ∅ Addition Rule for Mutually Exclusive Events: If A∩B=∅. (A) 0.

65 = P(L) + P(S) − P ( L ∩ S ) P ( L ∩ S ) = 0.40 P ( L ∪ S ) = 0.30 and P(L) = 0.65 P(S) = 0.Solution: Let L be lab work and S be a visit to a specialist.05 = 0.2 (B) 0.30 − P ( L ∩ S ) Answer A 9 Venn Diagrams Can Help: You are given: P ( A ∪ B ) = 0.4 (D) 0. Determine P[ A].9.40 + 0.8 10 Copyright ACTEX 2006 .6 (E) 0.35 = 1− P ⎡( L ∪ S ) ⎤ ⎣ ⎦ ⎣ ⎦ P ( L ∪ S ) = 0.3 (C) 0. P ⎡∼ ( L ∪ S ) ⎤ = 0.7 and P ( A ∪ B′ ) = 0. (A) 0.

10 Unshaded region P ( A ∪ B′ ) = 0. How many policyholders are young. and 7. 3. Area of the shaded region must be 0.7 Subtracting the area of the shaded region: Answer D P(A) = 0.000 are young.010 married males.400 young married persons.Venn Diagrams Can Help: A B 0.000 are married. male/female. 600 are young married males. They can also be classified as 1. and 1. female.9. Each policyholder is classified as young/old. 3. Of these. and married/single.320 young males.600 are male.6 11 A More Complicated Venn Diagram: An insurance company has 10.10 The total area of the two circles represents: P ( A ∪ B ) = 0. 4.7 − 0. and single? (A) 280 (B) 423 (C) 486 (D) 880 (E) 896 12 Copyright ACTEX 2006 .000 policyholders.1 = 0.

A More Complicated Venn Diagram: Y=3. 000 − 720 − 600 − 800 = 880 Answer D H = married 14 Copyright ACTEX 2006 .000 M 720 600 800 Y = young M = male H = married H 13 A More Complicated Venn Diagram: Y=3.000 880 M 720 600 800 H Y = young M = male 3.

B. 16 Copyright ACTEX 2006 . As part of this plan. Determine the probability that a randomly chosen employee will choose no coverage. y. 1/3. B. each employee may choose exactly two of the supplementary coverages A. (A) 0 (B) 47/144 (C) 1/2 (D) 97/144 (E) 7/9 15 Trickier Problem. and 5/12. and C are 1/4.Some Problems are Trickier: An insurer offers a health plan to the employees of a company. cont. z. respectively.: A 0 x C y 0 0 z 0 B Find P ⎡∼ ( A ∪ B ∪ C ) ⎤ ⎣ ⎦ = 1− ( x + y + z ) This is a linear system for x. The proportions of the employees that choose coverages A. or may choose no supplementary coverage. and C.

: A 1 B P(A) = x + y + 0 = 0 0 4 y 1 0 P(B) = 0 + y + z = x z 3 5 0 P(C) = x + 0 + z = C 12 Solution: x = 2/12. y = 1/12.Trickier Problem. z = 3/12 6 1 P ⎡∼ ( A ∪ B ∪ C ) ⎤ = 1− ( x + y + z ) = 1− = ⎣ ⎦ 12 2 Answer C 17 More Probability Rules: Conditional probability by counting for equally likely outcomes n ( A ∩ B) P(A|B) = n (B ) Definition: For any two events A and B. the conditional probability of A given B is defined by P ( A ∩ B) P(A|B) = P (B ) 18 Copyright ACTEX 2006 . cont.

More Probability Rules: Multiplication Rule for Probability P ( A ∩ B ) = P(A|B) P ( B ) 19 Exercise: A researcher examines the medical records of 937 men and finds that 210 of the men died from causes related to heart disease. 312 of the 937 men had at least one parent who suffered from heart disease. of these 312 men. 102 died from causes related to heart disease. and. 20 Copyright ACTEX 2006 .

115 0.514 21 Solution: A: 312 H: 210 937 A = At least one parent with heart disease H = Died of causes related to heart disease Find P ( H |∼ A ) = n ( H∩ ∼ A ) n (∼ A) 22 Copyright ACTEX 2006 .327 0. cont.173 0.224 0. (A) (B) (C) (D) (E) 0. given that neither of his parents suffered from heart disease.Exercise.: Find the probability that a man randomly selected from this group died of causes related to heart disease.

173 n (∼ A) 625 Answer B 24 Copyright ACTEX 2006 .Solution: A: 312 102 108 H: 210 937 A = At least one parent with heart disease H = Died of causes related to heart disease n ( A ) = 312 n ( ~ A ) = 937 − 312 = 625 n ( A ∩ H ) = 102 n(H∩ ∼ A) = n(H) − 102 = 108 23 Solution: A: 312 102 108 H: 210 937 A = At least one parent with heart disease H = Died of causes related to heart disease P ( H |∼ A ) = n ( H∩ ∼ A ) 108 = = 0.

given that she does not have risk factor A? (A) (B) (C) (D) (E) 0. given that she has A and B. the probability is 0.12 that she has exactly these two risk factors (but not the other). and C.467 0.1 that a woman in the population has only this risk factor (and no others). For any two of the three factors.484 0.280 0. denoted by A. the probability is 0. is 1/3.: What is the probability that a woman has none of the three risk factors. cont. For each of the three factors.A Harder Conditional Problem: An actuary is studying the prevalence of three health risk factors. The probability that a woman has all three risk factors.311 0. B. 25 A Harder Conditional Problem. within a population of women.700 26 Copyright ACTEX 2006 .

P ( A ∩ B ∩ C ) = x is not given.DeMorgan’s Laws: ∼ A∩ ∼ B =∼ ( A ∪ B ) ∼ A∪ ∼ B =∼ ( A ∩ B ) 27 Harder Problem Solution: We want to find ∼ P(∼ A∩ ∼ B∩ ∼ C | A) = A x B P(∼ A∩ ∼ B∩ ∼ C) P (∼ A) P[∼ (A ∪ B ∪ C)] P (∼ A) = C But . 28 Copyright ACTEX 2006 .

10 .12 .12 x 1 = → x = 0.12 x C P ( A ∩ B ) = x + 0. cont.12 .12 3 30 Copyright ACTEX 2006 .10 . A . cont.12 x .12 C Harder Problem Solution.: Probability of a woman having all three risk factors given that she has A and B is 1/3.Harder Problem Solution.06 x + 0.10 .10 A .: Fill in 0.10 29 B . and fill in 0.12 in each of the areas representing exactly two risk factors .10 P (A ∩ B ∩ C) = x .12 .10 in each of the areas representing exactly one risk factor. P ( A ∩ B ∩ C|A ∩ B) P (A ∩ B ∩ C) 1 B = = P ( A ∩ B) 3 .

12 .72 = 0.12 + 0.10 .: P(∼ A∩ ∼ B∩ ∼ C | A) = ∼ P[∼ (A ∪ B ∪ C)] P (∼ A) A .06 + 3 ( 0.12) + 3 ( 0.12 .10 .12 + 0.10 ) = 0.12 .60 = 0.28 C Harder Problem Solution.10 → P ( ∼ A ) = 0.60 = 0.10 31 B .28 0.10 .: P ( A ) = 0.40 P ( A ∪ B ∪ C ) = 0.10 B 0.12 .12 . cont.467 = C Answer C 32 Copyright ACTEX 2006 . cont.10 P ⎡∼ ( A ∪ B ∪ C ) ⎤ ⎣ ⎦ = 1− 0.72 A .12 .Harder Problem Solution.06 .06 .06 + 0.

34 Copyright ACTEX 2006 . (iii) The probability that a car owner purchases both collision and disability coverages is 0. are independent if P(A |B) = P(A) Multiplication Rule for Independent Events If A and B.More Probability Rules: Definition: Two events A and B. (ii) The event that a car owner purchases collision coverage is independent of the event that he or she purchases disability coverage. are independent.15 . P ( A ∩ B ) = P ( A ) P (B ) 33 Exercise: An actuary studying insurance preferences makes the following conclusions: (i) A car owner is twice as likely to purchase collision coverage as disability coverage.

We need to find P ⎡∼ ( C ∪ D ) ⎤ = 1− P ( C ∪ D ) .: What is the probability that an automobile owner purchases neither collision nor disability coverage? (A) 0.67 (E) 0. cont.15 36 Copyright ACTEX 2006 .18 (B) 0.Exercise.48 (D) 0.82 35 Solution: Let C be collision insurance and D be disability insurance.33 (C) 0. ⎣ ⎦ i) P(C) = 2 P(D) ii) P ( C ∩ D ) = P(C) P(D) iii) P(C ∩ D) = 0.

: 0.15 = P ( C ∩ D ) = P(C) P(D) = 2P(D)2 P(D)2 = 0.950 (E) 0.075 → P(D) = 0.945 (D) 0.995 38 Copyright ACTEX 2006 .67 = 0. The same test indicates the presence of the disease 0.Solution. 1% of the population actually has the disease.075 + 0. (A)0.33 ⎣ ⎦ Answer B 37 Bayes Theorem -. Calculate the probability that a person has the disease given that the test indicates the presence of the disease.Simplify with Trees: A blood test indicates the presence of a particular disease 95% of the time when the disease is actually present.075 P(C) = 2 P(D) = 2 0.657 (C) 0.075 P(C ∪ D) = P(C) + P(D) − P(C ∩ D) = 2 0.075 − 0.67 P ⎡∼ ( C ∪ D ) ⎤ = 1− P ( C ∪ D ) = 1− 0. cont.5% of the time when the disease is not present.15 = 0.324 (B) 0.

005 .0095 + 0.00495 P (T ) Answer B 40 Copyright ACTEX 2006 .95 . cont.: .99 T ~T 0.01 .0095 = P ( D ∩ T ) D ~D .995 T 0.05 .657 0.Solution: D = Person has the disease T = Test indicates the disease We need to find P ( D |T ) = P (D ∩ T ) P (T ) 39 Solution.0095 = = 0.00495 = P ( ~ D ∩ T ) ~T P ( D |T ) = P (D ∩ T ) 0.

A2 . If A1. then P ( E ∩ A1 ) P ( A1| E ) = P (E) P ( A1 ) P ( A1| E ) = P ( A1 ) P ( A1| E ) + + P ( An ) P ( An | E ) 42 Copyright ACTEX 2006 . 41 Theorem: Bayes’ Theorem: Let E be an event.Probability Rules: Law of Total Probability: Let E be an event. then P ( E ) = P ( A1 ∩ E ) + P ( A2 ∩ E ) + .. … An partition the sample space. +P ( An ∩ E ) . A2 . If A1.. … An partition the sample space.

005 of dying in the next year.0001 (B) 0. Each standard policyholder has probability 0. and each ultrapreferred policyholder has probability 0. cont.0071 (D) 0. 43 Exercise. What is the probability that the deceased policyholder was ultra preferred? (A) 0. each preferred policyholder has probability 0.Exercise: An insurance company issues life insurance policies in three separate categories: standard.001 of dying in the next year.0141 (E) 0.: A policyholder dies in the next year. 50% are standard. and 10% are ultrapreferred. and ultra-preferred.010 of dying in the next year. preferred. Of the company’s policyholders.0010 (C) 0.2817 44 Copyright ACTEX 2006 . 40% are preferred.

0001+ .5 .005 Answer D 45 Exercise: The probability that a randomly chosen male has a circulation problem is 0.0001 P (U | D ) = P (U ∩ D ) P (D ) .01 .002 + . given that he a smoker? (A) 1/4 (B) 1/3 (C) 2/5 (D) 1/2 (E) 2/3 46 Copyright ACTEX 2006 .4 .001 D .005 D .1 S P U .0141 .002 .Solution . Males who have a circulation problem are twice as likely to be smokers as those who do not have a circulation problem.0001 = = .25 .005 D . What is the conditional probability that a male has a circulation problem.

75x P ( C|S ) = P (C ∩ S) .5 = = = .75x 1.25 .: C 2x S .5x .5x + .25 Answer C 48 Copyright ACTEX 2006 .75 ~C x S . We do know that 2x = P ( S | C ) since those who have a circulation problem are twice as likely to be smokers. cont. 47 Solution.5x . We do not know x = P ( S |~ C ) .Solution: C = Circulatory problem S = Smoker We need to find P ( C | S ) .40 P (S ) .

Notation: V ( X ) = σ 2 V (X ) = E (X 2 ) − E (X ) = E (X 2 ) − μ 2 2 V ( aX + b ) = a 2 V ( X ) 50 Copyright ACTEX 2006 . A Property of Expected Value: E ( aX + b ) = a E ( X ) + b 49 Variance: Definition: The variance of a random variable X is 2 2 V ( X ) = E ⎡( X − μ ) ⎤ = ∑ ( x − μ ) p ( x ) ⎣ ⎦ Standard Deviation: σ = V ( X ) . E ( x ) = μ .Expected Value: Definition: The expected value of X is defined by E (X ) = ∑ x p ( x) The expected value is also referred to as the mean of the random variable X and denoted by Greek letter μ .

10 40 0. cont.Exercise: A probability distribution of claim sizes is given in this table: Claim Size Probability 20 0.20 60 0.15 30 0.10 70 0.30 51 Exercise.: What percentage of the claims are within one standard deviation of the mean claim size? (A)45% (B) 55% (C) 68% (D) 85% (E) 100% 52 Copyright ACTEX 2006 .10 80 0.05 50 0.

8 A value is within one standard deviation of the mean if it is in the interval [ μ − σ .2 55 70 80 76.Solution: Claim Size 20 30 40 50 60 70 80 Total Probability 0.15 0. 20 30 40 50 60 33.10 0. 76. μ + σ ] .20 0. in the interval [33.8 54 E ( X ) = ∑ x p ( x ) = 55 Copyright ACTEX 2006 . cont.: σ 2 = V ( X ) = E ( X 2 ) = μ 2 = 3500 − 552 = 475 σ = 475 = 21.10 0.2.30 1.05 0. that is.00 xp(x) x2p(x) 3 3 2 10 6 7 24 55 60 90 80 500 360 490 1920 3500 53 Solution.10 0.8] .

45 55 Z-Score: Definition: For any possible value x of a random variable.8 Thus.: The values of x in this interval are 40. the probability of being within one standard deviation of the mean is: p(40) + p(50) + p(60) + p(70) = .05 + . and 70. 50.Solution. 60. cont.10 = .10 + . σ 56 Copyright ACTEX 2006 . 20 30 40 50 60 70 80 33. x-μ z= The z score measures the distance of x from E ( X ) = μ in standard deviation units.20 + .2 55 76.

Y independent V ( X + Y ) = V ( X ) + V (Y ) 58 Copyright ACTEX 2006 . the probability that X is within k standard deviations of the 1 mean is at least 1− 2 . k P(μ . Y ) For X.Theorem: Chebychev’s Theorem: For any random variable X.kσ ≤ X ≤ μ + kσ ) ≥ 1- 1 k2 57 Additional Properties of V(X): V ( X + Y ) = V ( X ) + V (Y ) + 2cov ( X .

Exercise: The profit for a new product is given by Z = 3X – Y − 5. 60 Copyright ACTEX 2006 .V (Y ). What is the variance of Z? (A) 1 (B) 5 (C) 7 (D) 11 (E) 16 59 Solution: V (Z) = V ( 3X − Y − 5) = V ( 3X − Y ) = V ( 3X + ( −Y ) ) = 9 (1) + 2 = 11 independence 2 = V ( 3X ) + V ( −Y ) = 32 V ( X ) + ( −1) V (Y ) Answer D Note! Observe the wrong answer which you would obtain if you mistakenly wrote V (3X . X and Y are independent random variables with V(X) = 1 and V(Y) = 2. This is choice C. and is a common careless mistake.Y ) = V (3X ) .

2X the random variable for the cost after 20% inflation. what will be the variance of the annual cost of maintaining and repairing a car? (A) 208 (B) 260 (C) 270 (D) 312 (E) 374 61 Solution: Let X be the random variable for the present cost. and Y=1. V (Y ) = V (1.. If a tax of 20% is introduced on all items associated with the maintenance and repair of cars (i.Exercise: A recent study indicates that the annual cost of maintaining and repairing a car in a town in Ontario averages 200 with a variance of 260. everything is made 20% more expensive). We are asked to find V(Y).44 ( 260 ) = 374.22 V (X ) = 1.4 Answer E 62 Copyright ACTEX 2006 . = 1.e.2X ) .

64 Copyright ACTEX 2006 . ar 2 . ar n ..Geometric Series Review: A geometric sequence is of the form a . 2.r ⎟ ⎝ ⎠ The number r is called the ratio.r ⎠ 63 Geometric Distribution: P ( X = k ) = q k p... we can sum the infinite geometric series: ⎛ 1 ⎞ a + ar + ar 2 + . = a ⎜ ⎟ ⎝ 1... ar 3 . 3.. + ar n + . . + ar = a ⎜ 1. 1. ar . … q p2 V (X ) = where X= the number of failures before the first success in a repeated series of independent success-failure trials with P ( Success ) = p.. If |r|<1. The sum of the series for r ≠ 1 is given by: ⎛ 1− r n +1 ⎞ 2 n a + ar + ar + ... E (X ) = q p k = 0.

what is the probability that a policyholder files more than one claim during the period? (A) 0.Geometric Distribution Alternative: Here. an actuary makes the simplifying assumption that for all integers n ≥ 0.80 (E) 0. you are looking at the number of trials needed to get to the first success.04 (B) 0. In this formulation. P (Y = k ) = q k −1 p . E (Y ) = 1 p k = 1. 2. 1 p n +1 = p n where p n represents the probability 5 that the policyholder files n claims during the period. … q p2 V (Y ) = 65 Exercise: In modeling the number of claims filed by an individual under an automobile policy during a three-year period.16 (C) 0. 3. Under this assumption. you are looking at Y = X + 1.20 (D) 0.96 66 Copyright ACTEX 2006 .

Solution: We are not given p 0 . p0 ⎜ ⎟ . + ⎜ ⎟ + . … ⎝ 5⎠ ⎝ 5⎠ ⎝ 5⎠ 67 Solution. ⎥ ⎝ 5⎠ ⎢ 5 ⎝ 5⎠ ⎝ 5⎠ ⎥ ⎣ ⎦ ⎛ ⎞ ⎜ 1 ⎟ 5 = p0 ⎜ = p0 1⎟ 4 ⎜ 1− ⎟ ⎝ 5⎠ 4 → p0 = 5 68 Copyright ACTEX 2006 . cont. p0 ⎜ ⎟ . Look at the first few 2 2 terms: ⎛ 1⎞ ⎛ 1⎞ ⎛ 1⎞ p0 .... p0 ⎜ ⎟ ..: n ⎡ 1 ⎛ 1 ⎞2 ⎛ 1 ⎞3 ⎤ ⎛ 1⎞ 1 = p 0 ⎢1+ + ⎜ ⎟ + ⎜ ⎟ + .

: ⎡ 4 4 ⎛ 1 ⎞⎤ P ( N > 1) = 1− P ( N ≤ 1) = 1− ⎢ + ⎜ ⎟ ⎥ = .04 ⎣ 5 5 ⎝ 5 ⎠⎦ Answer A Note! The probability distribution has the form of a 1 q = . success-failure trials with P(S) = p . 5 69 Binomial Distribution: Given n independent. n ⎝k⎠ E ( X ) = np V ( X ) = np (1− p ) = npq 70 Copyright ACTEX 2006 . P ( F ) = 1− p = q ⎛n⎞ P(X = k) = ⎜ ⎟ p k (1− p) n-k ⎝k⎠ ⎛ n ⎞ k n-k = ⎜ ⎟ p (q) . k = 0. … .Solution. so it must be geometric distribution with 5 4 true that p 0 = p = . 1. cont.

r) r r! n! = r !(n − r)! n (n − 1 ⋅ ⋅ ⋅ (n − r + 1 ) ) = r! ⎛10 ⎞ 10! 10 ⋅ 9 ⎜ 2 ⎟ = 2!8! = 2 ⋅ 1 = 45 ⎝ ⎠ () n ! = n ( n − 1) . C.8 ) = 1.Notation Review: n = C(n . B.2 = p .2 ) ( . P ( S ) = .2 )( .8 ) ≈ .8 ⎛ 10 ⎞ 2 8 P ( X = 2 ) = ⎜ ⎟ ( .302 ⎝2⎠ E ( X ) = 10 ( ..2 ) = 2 V ( X ) = 10 ( . r) = P(n . ( 2 )1 71 Example: Guessing on a 10 question multiple choice quiz with choices A.6 72 Copyright ACTEX 2006 . E. n = 10. q = .. D.

192 (C) .469 73 Solution: Denote the random variables for the number of participants completing in each group by A and B. We need P ⎡( A ≥ 9 & B < 9 ) or ( B ≥ 9 & A < 9 ) ⎤ ⎣ ⎦ = P ( A ≥ 9 & B < 9 ) + P (B ≥ 9 & A < 9 ) Ind = P ( A ≥ 9 ) P (B < 9 ) + P (B ≥ 9 ) P ( A < 9 ) The two groups are independent and have identical binomial probability distributions.2 (independently of the other participants). 74 Copyright ACTEX 2006 .376 (E).235 (D) . Individual participants in the study drop out before the end of the study with probability 0.096 (B) . but not in both groups? (A) . What is the probability that at least 9 participants complete the study in one of the two groups.Exercise: A study is being conducted in which the health of two independent groups of ten policyholders is being monitored over a oneyear period of time.

469 Answer E 75 Harder Bayes Thrm.376 ( . 2% of the vials are ineffective.8. 76 Copyright ACTEX 2006 .624 ) + .624 ) = .Solution.624 P ( A ≥ 9) P (B < 9) + P (B ≥ 9) P ( A < 9) = .2 ) = . The hospital tests 30 randomly selected vials from a shipment and finds that one vial is ineffective. 10% of the vials are ineffective. For every other company.376 → P(B < 9) = .810 + ⎜ ⎟ .376 ( .624 P ( B ≥ 9 ) = .89 ( .376 ⎝9 ⎠ P(A < 9) = 1− P ( A ≥ 9 ) = . P ( A ≥ 9 ) = P ( A = 10 ) + P ( A = 9 ) ⎛ 10 ⎞ = . cont.: A is binomial with n=10 independent trials and probability of completion p=0./Binomial Exercise: A hospital receives 1/5 of its flu vaccine shipments from Company X and the remainder of its shipments from other companies. For Company X’s shipments. Each shipment contains a very large number of vaccine vials.

cont.14 (C) 0.9 29 ) = .63 (E) 0.: What is the probability that this shipment came from Company X? (A) 0.1) ( ./Binomial Exercise. If the shipment is from company X.Bayes Thrm. the number of defectives in 30 components is a binomial random variable with n=30 and p=0.37 (D) 0.86 77 Solution: X = Shipment came from company X I = Exactly 1 vial out of 30 tested is ineffective We are asked to find P ( X | I ) .10 (B) 0.1.141 ⎝1 ⎠ 78 Copyright ACTEX 2006 . The probability of one defective in a batch of 30 from X is ⎛ 30 ⎞ P ( I | X ) = ⎜ ⎟ ( .

⎛ 30 ⎞ P ( I |~ X ) = ⎜ ⎟ ( .9829 ) = .141 . cont.: X = Shipment came from company X I = Exactly 1 vial out of 30 tested is ineffective We are asked to find P ( X | I ) . cont.2672 Answer A 80 Copyright ACTEX 2006 . the number of defectives in 30 components is a binomial random variable with n=30 and p=0.0955 . If the shipment isn’t from company X.0282 X .2672 P ( X |I ) = = .334 ~X P (X ∩ I) P (I ) I .0282 = .334 ⎝1 ⎠ 79 Solution.02.: .02 ) ( .0282 + .Solution.8 I .2 .

e −2 21 ≈ . 2. … E (X ) = λ V (X ) = λ 81 Example: Accidents occur at an average rate of λ = 2 per month.Poisson Distribution: X is Poisson with mean λ. e − λ λk . Let X = the number of accidents in a month. 3. P(X = k) = k! k = 1.271 P ( X = 1) = 1! E (X ) = V (X ) = 2 82 Copyright ACTEX 2006 .

what is the variance of the number of claims filed? (A) 1/ 3 (B) 1 (C) 2 (D) 2 (E) 4 83 Solution: P ( X = 2) = 3 P ( X = 4 ) ⎛ e −λλ 4 ⎞ e −λλ2 = 3⎜ 2! 4! ⎟ ⎝ ⎠ 4λ 2 = λ 4 → λ = 2 Answer D 84 Copyright ACTEX 2006 . If the number of claims filed has a Poisson distribution.Exercise: An actuary has discovered that policyholders are three times as likely to file two claims as to file four claims.

234 ⎛ 50 ⎞ ⎜ 5⎟ ⎝ ⎠ 85 Hypergeometric Probabilities: 1 2 3 Copyright ACTEX 2006 A sample of size n is being taken from a finite population of size N. The random variable of interest is X. 86 .Hypergeometric Example: A company has 20 male and 30 female employees. The population has a subgroup of size r ≥ n that is of interest. the number of members of the subgroup in the sample taken. What is the probability that 3 males and 2 females are chosen? Solution: ⎛ 20 ⎞ ⎛ 30 ⎞ ⎜ 3 ⎟⎜ 2 ⎟ ⎝ ⎠ ⎝ ⎠ ≈ 0. 5 employees are chosen at random for drug testing.

… .n ⎞ ⎛ r ⎞⎛ V ( X ) = n ⎜ ⎟ ⎜1− ⎟ ⎜ ⎟ ⎝ N ⎠ ⎝ N ⎠ ⎝ N -1 ⎠ 87 Previous Example. cont. cont. N = 50 n=5 r = 20 ⎛ 30 ⎞ ⎛ 20 ⎞ ⎜5.: ⎛N .Hypergeometric Probabilities.k⎟⎜k ⎟ ⎠⎝ ⎠ P(X = k) = ⎝ ⎛ 50 ⎞ ⎜ 5⎟ ⎝ ⎠ ⎛ 20 ⎞ E(X ) = 5 ⎜ ⎟ = 2 ⎝ 50 ⎠ ⎛ 20 ⎞ ⎛ 20 ⎞ ⎛ 50 . n ⎛r⎞ E (X ) = n ⎜ ⎟ ⎝N⎠ r ⎞⎛ N .: X = number of males chosen in a sample of 5.k ⎟⎜k⎟ ⎠⎝ ⎠ . P(X = k) = ⎝ ⎛N⎞ ⎜n ⎟ ⎝ ⎠ k = 0.r ⎞⎛ r ⎞ ⎜ n .5 ⎞ V (X ) = 5 ⎜ ⎟ ⎜ 1− ⎟⎜ ⎟ ⎝ 50 ⎠ ⎝ 50 ⎠ ⎝ 50 -1 ⎠ 88 Copyright ACTEX 2006 .

k = 0. Example: Play slot machine repeatedly with probability of success on each independent play P ( S ) = .05 = p. Let X be the number of failures before success r. 1.Negative Binomial Distribution: A series of independent trials has P(S) = p on each trial. ⎛ r + k -1⎞ k r P(X = k) = ⎜ q p . 2. 90 Copyright ACTEX 2006 . 3. … r -1 ⎟ ⎝ ⎠ E(X ) = rq p V (X ) = rq p2 89 The special case with r = 1 is the geometric random variable. Find the probability of exactly 4 losses (failures) before the second win (success r=2).

: Possible sequences: SFFFFS FSFFFS FFSFFS FFFSFS FFFFSS 4 Single sequence probability : .052 ( . The number of accidents that occur in any given month is independent of the number of accidents that occur in all other months.95) ≈ . 92 Copyright ACTEX 2006 .05) ( .Example.95) ⎛ 5⎞ Number of sequences: ⎜ ⎟ = 5 ⎝1 ⎠ Solution: 5 ( .0818 2 4 91 Exercise: A company takes out an insurance policy to cover accidents at its manufacturing plant. The probability that one or more accidents will occur during any given month is 3/5. cont.

Note that P(S) = p = 3/5.: Calculate the probability that there will be at least four months in which no accidents occur before the fourth month in which at least one accident occurs.41 93 Solution: This is a negative binomial distribution problem.e. X is negative binomial with r = 4 and p=3/5.. cont.Exercise. Let X be the number of months with no accidents before the fourth month with at least one accident –i.12 (C) 0. (A) 0. the number of failures before the fourth success.01 (B) 0. Success S = month with at least one accident Failure F = month with no accidents. 94 Copyright ACTEX 2006 .23 (D) 0.29 (E) 0.

28979 Answer D 96 Copyright ACTEX 2006 .: P ( X ≤ 3 ) = . cont.16589 = .20736 ⎝ 1 ⎠ ⎝ 5 ⎠ 4⎝ 5 ⎠ 2 ⎛ 5⎞ ⎛ 3 ⎞ ⎛ 2 ⎞ P ( X = 2 ) = ⎜ ⎟ ⎜ ⎟ ⎜ ⎟ = .16589 ⎝3⎠⎝ 5 ⎠ ⎝ 5 ⎠ 95 Solution.20736 + .12960 + .71021 = .: We are asked to find P ( X ≥ 4 ) = 1− P ( X ≤ 3 ) = 1− ⎡P ( X = 0 ) + P ( X = 1) + P ( X = 2 ) + P ( X = 3 ) ⎤ ⎣ ⎦ 4 ⎛3⎞ P ( X = 0 ) = ⎜ ⎟ = 0.12960 ⎝ 5⎠ 4 ⎛ 4⎞⎛ 3 ⎞ ⎛ 2 ⎞ P ( X = 1) = ⎜ ⎟ ⎜ ⎟ ⎜ ⎟ = .20736 ⎝2⎠⎝ 5 ⎠ 4 ⎝ 5 ⎠3 ⎛6⎞⎛ 3 ⎞ ⎛ 2 ⎞ P ( X = 3 ) = ⎜ ⎟ ⎜ ⎟ ⎜ ⎟ = . cont.71021 P ( X ≥ 4 ) = 1− P ( X ≤ 3 ) = 1− .20736 + .Solution.

y = ( x) ≤ b ) is given by the 3 P (=af≤(xX between x = a and xarea. under ) y =b P(a ≤ X ≤ b) = ∫ f (x) dx a b 97 ∫ ∞ −∞ f (x) dx = 1 Continuous Distribution Properties: Cumulative Distribution Function F(x) x F(x) = P(X ≤ x) = ∫ f (u) du Expected Value ∞ E(X ) = ∫ x f ( x ) dx −∞ −∞ Expected value of a function of a continuous random variable ∞ E ⎡g ( X ) ⎤ = ∫ g ( x ) ⋅ f ( x ) dx ⎣ ⎦ −∞ Mean of Y = aX + b E ( aX + b ) = a E ( X ) + b 98 Copyright ACTEX 2006 . 1 area bounded 2 The ftotaland the x axis isby the graph of 1.Definition of Continuous Distribution: The probability density function of a random variable X is a real valued function satisfying: f (x) ≥ 0 for all x.

otherwise ⎩ a+b E(X ) = 2 (b .μ )2 ] = ∫ (x .μ )2 f (x) dx −∞ Alternate Form of Variance Calculation 2 V (X ) = E(X 2 ) − [ E(X )] = E(X 2 ) − μ 2 Variance of Y = aX + b V (aX + b) = a 2V (X ) 99 Uniform Random Variable on [a. b]: ⎧ 1 ⎪ .a ≤ x ≤ b f ( x) = ⎨ b .Continuous Distribution Properties: Variance ∞ V (X ) = E[(X .a)2 V (X ) = 12 100 Copyright ACTEX 2006 .a ⎪0.

P ( 0 ≤ T ≤ 1) = F(1 = 1− e −2 ≈ .e .λt for t ≥ 0 E(T ) = 1 λ V (T ) = 1 λ2 101 Example: Waiting time for next accident. F(t ) = 1. f (t ) = λe . λ = rate.Exponential Distribution: Random variable T. λ = 2 accidents per month on average.865 ) E (T ) = 1 2 V (T ) = 1 4 * Exponential waiting time Poisson number of events * 102 Copyright ACTEX 2006 .λt . T is often used to model waiting time. parameter λ.

respectively. What is the probability that the first claim from a good driver will be filed within 3 years and the first claim from a bad driver will be filed within 2 years? 104 Copyright ACTEX 2006 .ax xn = lim ax = 0. ∫0 a n +1 for a > 0. for a > 0.Useful Exponential Facts: x →∞ lim x e ∞ n . and n a positive integer. x →∞ e n! .ax dx = 103 Exercise: The waiting time for the first claim from a good driver and the waiting time for the claim from a bad driver are independent and follow exponential distributions with 6 years and 3 years. x n e .

you know that 1/ μ = λ. the mean of the exponential is μ = 1/ λ.Exercise: 2 7 1 − − ⎞ − 1⎛ 3 6 2 (A) ⎜1− e − e + e ⎟ 18 ⎝ ⎠ 7 1 −6 e (B) 18 (C) 1− e (D) 1− e − 2 3 2 3 −e −e 2 − 1 2 1 2 +e +e − 7 6 1 3 7 − − − 1 1 −3 1 −2 1 − 6 (E) 1− e − e + e 3 6 18 105 Solution: Recall. G: Waiting time for 1st accident for good driver B: Waiting time for 1st accident for bad driver 1 G: λ G = 6 B: λ B = 1 3 x − ⎞ ⎛ FG (x) = ⎜ 1− e 6 ⎟ ⎝ ⎠ x − ⎞ ⎛ FB (x) = ⎜ 1− e 3 ⎟ ⎝ ⎠ 106 Copyright ACTEX 2006 . Thus if you are given the mean (as in this problem).

66 108 Copyright ACTEX 2006 .57 (E) 0. P ( G ≤ 3 & B ≤ 2) = P ( G ≤ 3) P (B ≤ 2) = FG ( 3 ) FB ( 2 ) 3 2 − ⎞⎛ − ⎞ ⎛ = ⎜1− e 6 ⎟⎜ 1− e 3 ⎟ ⎝ ⎠⎝ ⎠ = 1− e − 2 3 −e +e Answer C − 1 2 − 7 6 107 Exercise: The number of days that elapse between the beginning of a calendar year and the moment a high-risk driver is involved in an accident is exponentially distributed.43 (D) 0. Note that G and B are independent. An insurance company expects that 30% of high-risk drivers will be involved in an accident during the first 50 days of a calendar year.15 (B) 0. What portion of high-risk drivers are expected to be involved in an accident during the first 80 days of a calendar year ? (A) 0.34 (C) 0. cont.Solution.: Find P ( G ≤ 3 & B ≤ 2 ) .

: P(T ≤ 50) = F(50) = 1− e − λ 50 = 0. cont.4348 Answer B 110 Copyright ACTEX 2006 . 109 Solution. but we don’t know λ.Solution: T: time in days until the first accident for a high risk driver To find: P(T ≤ 80) = F(80). Use the given probability for the first 50 days to find it. λ= P(T ≤ 80) = F(80) = 1− e −80 λ = . −λt We know F(t ) = 1− e .30 ln ( 0.7 ) −50 Now we have λ and can finish the problem.

Calculate the median benefit for this policy. Let X be a continuous random variable and 0 ≤ p ≤ 1. X.004 x for x ≥ 0 f ( x) = ⎨ otherwise ⎩0 where c is constant. The 100pth percentile of X is the number x p defined by F(x p ) = p. (A) 161 (B) 165 (C) 173 (D) 182 (E) 250 112 Copyright ACTEX 2006 .Definitions: The mode of a continuous random variable is the value of x for which the density function f(x) is a maximum. The median m of a continuous random variable X is defined by F(m) = P(X ≤ m) = 0. Note that the 50th percentile is the median.50. up to a maximum benefit of 250. 111 Exercise: An insurance policy reimburses dental expense. The probability density function for X is: ⎧ce −0.

50% of the benefits paid are still less than 173.50 ) m= = 173.004 x be exponential with c = .) 113 Solution.50 = e −.: Original expense X: cumulative distribution F(x) = 1− e −. Answer C 114 Copyright ACTEX 2006 .004 m → 0. but that takes extra time.50 = 1− e −.3 −. (Some of our students integrated the density function and set the total area under the curve equal to 1.004m ln ( . since .004 x .004 Actual benefit capped at 250.004e is the density function for the exponential with λ = . Thus the median m for X is obtained by solving the equation F(m) = 0.004. cont. Since 173.004.Solution: You can see by direct examination that X must −0.3 and 50% are greater.3 is less than 250.

Normal Random Variable: μ = E ( X ) and σ 2 = V ( X ) ( x -μ ) 2 2σ 2 f ( x) = 1 e 2πσ − 115 Transformation to Standard Normal: Transform any normal random variable X with mean μ and standard deviation σ into a standard normal random variable Z with mean 0 and standard deviation 1. 116 Copyright ACTEX 2006 . Z= X−μ σ = 1 σ X− μ σ Then probabilities can be calculated using the standard normal probability tables for Z.

0919 118 Copyright ACTEX 2006 . σ = 100 P ( 600 ≤ X ≤ 750 ) 650 − 500 ⎞ ⎛ 600 − 500 = P⎜ ≤Z≤ ⎟ 100 ⎠ ⎝ 100 = P (1 ≤ Z ≤ 1.9332 − .8413 = .Normal Distribution Table: 117 Standard Normal Example: X normal. μ = 500.5) = .

… .68 (B) 0. What is the approximate probability that there is a total of between 2450 and 2600 claims during a one-year period? (A) 0.82 (C) 0. X n be independent random variables all of which have the same probability distribution and thus the same mean μ and variance σ 2 .87 (D) 0. The number of claims filed by a policyholder under a vision care insurance policy during one year is a Poisson random variable with mean 2. Assume the numbers of claims filed by distinct policyholders are independent of one another. If n is large. the sum S = X1 + X 2 + … + X n will be approximately normal with mean n μ and variance n σ 2 . X 2 .95 (E) 1. 119 Exercise: An insurance company issues 1250 vision care insurance policies.Central Limit Theorem: Let X1.00 120 Copyright ACTEX 2006 .

….9772 − . i=1.Solution: X i : number of claims on policy i. 1250. cont.: Thus P ( 2450 ≤ S ≤ 2600 ) 2600 − 2500 ⎞ ⎛ 2450 − 2500 = P⎜ ≤Z≤ ⎟ 50 50 ⎝ ⎠ = P ( −1 ≤ Z ≤ 2 ) = . The total number of claims is S = X1 + … + X1250 By the central limit theorem.1581 = .8191 Answer B 122 Copyright ACTEX 2006 . S is approximately normal with E(S) = μ s = 1250(2) = 2500 V (S) = σ s 2 = 1250(2) = 2500 σ S = 2500 = 50 121 Solution. (Poisson) X i : iid with mean μ = 2 and variance σ 2 = 2.

950 0.900 0. xp − μ → x p = μ + z pσ zp = For example.576 P(Z<z) 0.99 = μ + z .96) = .Normal Distribution Percentiles: The percentiles of the standard normal can be determined from the tables. if X is a standard test score random variable with mean μ = 500 and standard deviation σ = 100 then the 99th percentile of X is x . Commonly used percentiles of Z: Z 0.975 Thus the 97.96.645 1.842 1.6 124 σ Copyright ACTEX 2006 .800 0.990 0.326 (100 ) = 732.975 0. P(Z ≤ 1.850 0.5 percentile of the Z distribution is 1.995 123 Example: X: normal random variable with mean μ and and standard deviation σ .326 2.960 2.036 1.282 1. For example. Find x p the 100pth percentile of X using the 100pth percentile of Z.99σ = 500 + 2.

562. 328. i=1. 2025.977. 250 126 Copyright ACTEX 2006 . 500 = 11. S is approximately normal with E(S) = μ s = 3125(2025) = 6. X i : iid with mean μ = 3125 and variance 2 σ 2 = ( 250 ) .125 V (S) = σ s 2 = 250(2025) = 126.000 (B) 6. (A) 6.Exercise: A charity receives 2025 contributions. 562.343.784. ….328.000 (D) 6.338.000 (C) 6.000 125 Solution: X i : number of contributions i. 500 σ S = 126. Contributions are assumed to be independent and identically distributed with mean 3125 and standard deviation 250. The total contribution is S = X1 + … + X 2025 By the central limit theorem. Calculate the approximate 90th percentile for the distribution of the total contributions received.000 (E) 6.

Solution, cont.:

**Since z .90 = 1.282, the 90th percentile of S is
**

s .90 = 6, 328,125 + 1.282 (11, 250 ) = 6, 342, 547.5

Answer C

127

Theorem:

If X1, X 2 , … , X n are independent normal random variables with respective means μ 1, μ 2 , … , μ n and respective variances 2 σ 12 , σ 2 , … , σ n2 , then X1 + X 2 + … + X n is normal with mean μ 1 + μ 2 + … + μ n and variance 2 σ 12 + σ 2 + … + σ n2 . Note that this shows that you don’t need large n (as required by the Central Limit Theorem) to have a normal sum.

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Corollary:

Let X1, X 2 , … , X n be independent normal random variables all of which have the same probability distribution and thus the same 2 mean μ and variance σ . For any n, the sum S = X1 + X 2 + … + X n will be normal with mean n μ and variance n σ 2 .

129

Corollary applied to sample mean X :

Let X1, X 2 , … , X n be iid normal random variables with mean μ and variance σ 2 . The sample mean is defined to be S X1 + ... + X n X= = n n For any n, the sample mean X will be normal with mean μ and variance

σ2

n

.

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Exercise:

Claims filed under auto insurance policies follow a normal distribution with mean 19,400 and standard deviation 5,000. What is the probability that the average of 25 randomly selected claims exceeds 20,000?

(A) 0.01 (B) 0.15 (C) 0.27 (D) 0.33 (E) 0.45

131

Solution: X i : claim amount on policy i, i=1, …, 25. X i : iid with μ = 19, 400 and variance σ 2 = 5000 2.

The average of 25 randomly selected claims is S X1 + ... + X 25 X= = 25 25 E(X ) = μ = 19, 400 σ 2 50002 V (X ) = = = 1000 2 25 25 σ X = 1000 2 = 1000

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000 − 19. The light bulbs have independent lifetimes.: ⎛ 20.6 < Z ) = .Solution.2743 Answer C 133 Exercise: A company manufactures a brand of light bulb with a lifetime in months that is normally distributed with mean 3 and variance 1. 134 Copyright ACTEX 2006 . 400 ⎞ P ( 20. 000 ⎝ ⎠ = P ( . A consumer buys a number of these bulbs with the intention of replacing them successively as they burn out. 000 < X ) = P ⎜ < Z⎟ 1. cont.

Exercise: What is the smallest number of bulbs to be purchased so that the succession of light bulbs produces light for at least 40 months with probability at least 0. Total lifetime of the succession of n bulbs is S = X1 + X 2 + … + X n E(S) = μ S = 3n 2 V (S) = σ S = n (1) = n σS = n The succession of light bulbs produces light for at least 40 months with probability at least 0. i=1. n. 136 Copyright ACTEX 2006 .9772 . ….9772? (A) 14 (B) 16 (C) 20 (D) 40 (E) 55 135 Solution: X i : lifetime of light bulb i. X i : iid with μ = 3 and variance σ 2 = 1.

cont.Solution. The amount paid is usually a function of a random variable g(X). so to find pure premiums we use the theorem E ⎡g ( x ) ⎤ = ∫ g ( x ) f ( x ) dx ⎣ ⎦ −∞ ∞ 138 Copyright ACTEX 2006 . 3x 2 − 2x − 40 = 0 → x = n = 4 → n = 16 Answer B 137 Definition: The pure premium for an insurance is the expected value of the amount paid on the insurance.9772.9772 = P ( S ≥ 40 ) = P ⎜ ⎟ n ⎠ ⎝ n 40 − 3n ⎞ ⎛ = P⎜Z ≥ ⎟ n ⎠ ⎝ Z tables: P ( Z ≥ −2 ) = . 40 − 3n = −2 → 3n − 2 n − 40 = 0 n Make the substitution x = n .: ⎛ S − 3n 40 − 3n ⎞ ≥ .

9 Answer D 140 Copyright ACTEX 2006 . 10 ⎛ 2 ⎞ ∞ ⎛2⎞ E ( B ) = ∫ y ⎜ 3 ⎟ dy + ∫ 10 ⎜ 3 ⎟ dt 1 10 ⎝y ⎠ ⎝y ⎠ = −2y −1 10 1 −10y −2 ∞ 10 1⎤ 1 ⎤ ⎡ ⎡ = 2 ⎢1− ⎥ − 10 ⎢0 − ⎣ 10 ⎦ ⎣ 100 ⎥ ⎦ = 1.9 (E) 2.8 (D) 1. The policyholder’s loss.Insurance with a cap or policy limit: An insurance policy reimburses a loss up to a benefit limit of 10 . B=⎨ 10 ≤ y ⎩10. 1 < y < 10 ⎧y . follows a distribution with density function: ⎧2 y >1 ⎪ 3 f (y ) = ⎨ y ⎪0 otherwise ⎩ What is the expected value of the benefit paid under the insurance policy? (A) 1.0 139 Solution: Let B=the random variable for the benefit paid. Y.0 (B) 1.3 (C) 1.

1500) . Y: amount paid by insurance. 1500). Determine the standard deviation of the insurance payment in the event that the automobile is damaged. Find the standard deviation σ Y = V (Y ) . ⎧0. repair costs can be modeled by a uniform random variable on the interval (0. (A) 361 (B) 403 (C) 433 (D) 464 (E) 521 141 Solution: X: repair cost.Insurance with a deductible: The owner of an automobile insures it against damage by purchasing an insurance policy with a deductible of 250 . In the event that the automobile is damaged. 142 Copyright ACTEX 2006 . 0 < x ≤ 250 250 < x Density function of X is f(x) = 1/1500 on the interval (0. Y=⎨ ⎩ x − 250.

833 143 Solution. 027.: E (Y ) =∫ = 250 0 1500 ⎛ 1 ⎞ ⎛ 1 ⎞ dx + ∫ ( x − 250 ) ⎜ 0⎜ ⎟ ⎟ dx 250 1500 ⎠ 1500 ⎠ ⎝ ⎝ 2 1500 ( x − 250 ) 3000 250 = 520. cont.: E (Y 2 ) =∫ = 250 0 1500 1 ⎞ 2⎛ ⎛ 1 ⎞ 0⎜ dx + ∫ ( x − 250 ) ⎜ ⎟ ⎟ dx 250 ⎝ 1500 ⎠ ⎝ 1500 ⎠ 3 1500 ( x − 250 ) 4500 250 = 434.Solution. cont.778 144 Copyright ACTEX 2006 .

cont.Solution.5 ⎪0 otherwise ⎩ To cover its losses.6 ) 2.5 ( 0. 760. the manufacturer purchases an insurance policy with an annual deductible of 2.778 − 520.764 σ Y = V (Y ) = 162.93 (D) 0.76 = 403. 760.00 146 Copyright ACTEX 2006 . What is the mean of the manufacturer’s annual losses not paid by the insurance policy? (A) 0.5 ⎪ for x > 0.95 (E) 1.436 Answer B 145 Exercise: A manufacturer’s annual losses follow a distribution with density function ⎧ 2. 027.84 (B) 0.: V ( Y ) = E (Y 2 ) − E (Y ) 2 = 434.88 (C) 0.6 f ( x) = ⎨ x 3.8332 = 162.

.5 ∞ −2.6 ⎜ ⎟ ⎜ ⎟ x 3.: 2.5 ⎛ 2.93427 Answer C 148 Copyright ACTEX 2006 .5 2 = .6 ) E (Y ) = ∫ x ⎜ ⎟dx + ∫2 2 ⎜ ⎟dx .5 x −2.6 ) 2.5 ( 0. x ≥ 2 147 Solution.6 ) 2.6 ) 2.5 2 −1.5 ⎞ ⎞ ∞ ⎛ 2.6 < x < 2 Y=⎨ ⎩2.09859 = . Find E(Y). ⎧ x .5 x −1.5 x 3.83568 + .Solution: X: actual cost.5 ( 0. Y: part of loss not paid by policy.5 + .5 ⎝ ⎠ ⎝ ⎠ 2 = 2. cont.5 ( 0. Since there is a deductible of 2.6 5 ( 0.

1000].Exercise: An insurance policy is written to cover a loss. where X has a uniform distribution on [0. X. x<d ⎧0. Y: amount paid by insurance. x ≥ d 1 . Y=⎨ ⎩x − d . At what level must a deductible be set in order for the expected payment to be 25% of what it would be with no deductible? (A) 250 (B) 375 (C) 500 (D) 625 (E) 750 149 Solution: d: unknown deductible. 0 ≤ x ≤ 1000 Density function for X: f (x) = 1000 d ⎛ 1000 1 ⎞ ⎛ 1 ⎞ E (Y ) = ∫ 0 ⎜ dx + ∫ ( x − d ) ⎜ ⎟ ⎟dx d 0 1000 ⎠ 1000 ⎠ ⎝ ⎝ (x − d) = 2000 2 1000 (1000 − d ) = 2000 2 150 d Copyright ACTEX 2006 .

For the uniform X on [0. is exponential with λ = . FY ( y ) = P (Y ≤ y ) = P (1. X.01 1. cont.05 152 Copyright ACTEX 2006 .05X . Find FY (y ).25 E ( X ) .05 ⎠ = 1− e y −. After inflation of 5%.01x .Solution. 000 → d = 500 (1000 − d ) 2 Answer C 151 Finding the Density Function for Y=g(x): Example: Cost. E ( X ) = 500 and .01.05X ≤ Y ) Y ⎞ ⎛ ⎛ Y ⎞ = P⎜X ≤ = FX ⎜ ⎟ ⎟ 1. Note that FX ( x ) = 1− e −.25E ( X ) (1000 − d ) 2000 2 = 125 = 250.: Find d such that E (Y ) = . E (Y ) = .05 ⎠ ⎝ ⎝ 1.25E ( X ) = 125. 1000]. the new cost is Y = 1.

Example, cont.:

Y is exponential with λ =

.01 . 1.05

Density function: fY ( y ) = FY′ ( y ) Useful notation: S(x) = P ( X > x ) = 1− F ( x )

153

Density Function When Inverse Exists: Case 1. g(x) is strictly increasing on the sample space for X. Let h(y) be the inverse function of g(x). The function h(y) will also be strictly increasing. In this case, we can find FY(y) as follows: FY ( y ) = P(Y ≤ y ) = P(g(X ) ≤ y )

= P ⎡ h ( g ( X ) ) ≤ h(y )⎤ ⎣ ⎦ = P ( X ≤ h(y ) ) = FX ( h(y ) )

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Density Function When Inverse Exists: Case 2. g(x) is strictly decreasing on the sample space for X. Let h(y) be the inverse function of g(x). The function h(y) will also be strictly decreasing. In this case, we can find FY(y) as follows: FY ( y ) = P(Y ≤ y ) = P(g(X ) ≤ y )

= P ⎡ h ( g ( X ) ) ≥ h(y )⎤ ⎣ ⎦ = P ( X ≥ h(y ) ) = S X ( h(y ) )

155

Density Function When Inverse Exists:

We can find the density function fY(y) by differentiating FY(y). The final result can be written in the same way for both cases: fY ( y ) = fX ( h(y ) ) h′ ( y )

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Exercise: The time, T, that a manufacturing system is out of operation has cumulative distribution function ⎧ ⎛ 2 ⎞2 for t > 2 ⎪1− F(t ) = ⎨ ⎜ t ⎟ ⎝ ⎠ ⎪0 otherwise ⎩ The resulting cost to the company is Y = T 2 . Determine the density function of Y, for y > 4. (A) 4 (B) 8 (C) 8 (D) 16 (E) 1024 y5 y2 y 3/2 y3 y

157

Solution:

First find the cumulative distribution function for Y: FY ( y ) = P (Y ≤ y ) = P ( T 2 ≤ y ) = P T ≤ y

(

)

⎛ 2 ⎞ 4 = FT y = 1− ⎜ ⎟ = 1− y ⎝ y⎠ Then the density function for Y is: d d ⎛ 4⎞ 4 fY (y ) = FY ( y ) = 1− = dy dy ⎜ y ⎟ y 2 ⎝ ⎠

( )

2

Answer A

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408 10. 408 (A) 425 v /10.833 − 10.000 − 0. The value of a 10. cont. 000 ⎠ ⎦ 160 Copyright ACTEX 2006 . F(v). Determine the cumulative distribution function.04.04 ⎥ (E) 25 ⎢ln ⎜ ⎟ ⎣ ⎝ 10. 159 Exercise.04 (B) 25e (C) v − 10. 0. 000e v /10. 000 e R .000 − 10.000 initial investment in this account after one year is given by V = 10. of V for values of v that satisfy 0<F(v)<1.: 10.Exercise: An investment account earns an annual interest rate R that follows a uniform distribution on the interval (0. 408 (D) 25 v ⎡ ⎛ v ⎞ ⎤ − .08).

04. b−a R is uniform on (0.Solution: Uniform distribution fact to use here: F(x) = x−a . 000 ⎠ ⎣ ⎦ Answer E 162 Copyright ACTEX 2006 .04 ⎥ .04 ⎝ ⎝ 10. for 0. 0.04 FR ( r ) = . cont.: F ( v ) = P (V ≤ v ) = P (10. ⎟ ⎝ 10.08) r − .04 ⎛ ⎛ v ⎞⎞ 10. 000e R ≤ v ) ⎛ ⎛ v ⎞⎞ = P ⎜ R ≤ ln ⎜ ⎟⎟ ⎝ 10.04 ≤ r ≤ 0. 000 ⎠ ⎠ ⎝ ⎛ v ⎞ ln ⎜ ⎟ − . 000 ⎠ ⎠ ⎡ ⎛ v ⎞ ⎤ = 25 ⎢ln ⎜ − .04 Find the cumulative distribution function for V.08. 000 ⎠ = FR ⎜ ln ⎜ = ⎝ ⎟⎟ . . 161 Solution.

Y): S Min (t ) = P(min(X . Y ) > t ) = P(X > t & Y > t ) = S X ( t ) SY ( t ) independence = P(X > t ) ⋅ P(Y > t ) 164 Copyright ACTEX 2006 . 163 Independent Random Variable Results: X and Y independent random variables. Recall that for X exponential we have F ( x ) = 1− e − λx and S ( x ) = e − λx .Independent Random Variable Results: General results for the minimum or maximum of two independent random variables: Recall that the survival function of a random variable X is S X (t ) = P(X > t ) = 1− FX ( t ) . Find survival function for Min=min(X.

Y) is exponential with parameter β + λ. Find cumulative distribution for Max=max(X.Independent Random Variable Results: X and Y independent random variables. 166 Copyright ACTEX 2006 . Y): FMax (t ) = P(max(X . Y ) ≤ t ) = P(X ≤ t & Y ≤ t ) = FX ( t ) FY ( t ) = P(X ≤ t ) ⋅ P(Y ≤ t ) independence 165 Exponential Random Variable Results: Minimum of independent exponential random variables: X and Y with parameters β and λ. S Min (t ) = S X ( t ) SY ( t ) = e − β t e − λt = e −( β + λ ))t Min=min(X.

where Max = max ( X1. fire. (A) 0. X 3 : losses due to storm.414 (B) 0. exponentially distributed random variables with respective means 1. fire. X 2 . X 2 .586 Answer E 168 Copyright ACTEX 2006 . X 3 ) : FMax (t ) = FX1 ( t ) FX2 ( t ) FX3 ( t ) = (1− e − x )(1− e − x /1.5 )(1− e −3/ 2.Exercise: In a small metropolitan area.586 = . 1.002 (C) 0. respectively. Determine the probability that the maximum of these losses exceeds 3.4 ) = . Find P [ Max > 3] .4 ) P(Max ≤ 3) = FMax (3) P [ Max > 3] = 1− .0.5.5 )(1− e − x / 2. and 2. annual losses due to storm.4 .159 (E) 0. and theft.050 (D) 0. and theft are assumed to be independent.414 = (1− e −3 )(1− e −3/1.287 167 Solution: X1.

Moments of a Random Variable: Definition: The nth moment of X is E ( X n ) . Moment Generating Function: Let X be a discrete random variable. The moment generating function MX ( t ) is defined by MX (t ) = E(e t X ) = ∑ e t x p(x) 169 Finding the nth moment: Finding the nth moment using the moment generating function: MX ( n ) (0) = ∑ x n p(x) = E(X n ) 170 Copyright ACTEX 2006 .

Discrete Random Variable Example: x p(x) etx 0 .5 e0t=1 1 .3 ) + e 2t ( . 172 Copyright ACTEX 2006 .2 )( 2 ) = E ( X ) X 171 MGF Useful Properties: MaX +b ( t ) = e tb MX ( at ) If a random variable X has the moment generating function of a known distribution. then X has that distribution.3 ) + 1( .2 e2t MX ( t ) = 1( .3 ) + e 2t ( .3 e1t 2 .2 ) M′ ( t ) = 0 + e t ( .5) + e t ( . For X and Y independent. MX +Y (t ) = MX (t ) MY (t ).2 )( 2 ) X M′ ( 0 ) = 0 + 1( .

: (A) 19 + 8 e t 27 27 (B) 1 + 2e t ⎛1 2 t⎞ (C) ⎜ + e ⎟ ⎝3 3 ⎠ 1 8 3t (D) + e 27 27 1 2 3t (E) + e 3 3 3 174 Copyright ACTEX 2006 . X 3 be a random sample from a discrete distribution with probability function ⎧1 ⎪ 3 for x = 0 ⎪ ⎪2 p ( x) = ⎨ for x = 1 3 ⎪ ⎪0 otherwise ⎪ ⎩ Determine the moment generating function. M(t ) of Y = X1 X 2 X 3 . 173 Exercise. cont. X 2 .Exercise: Let X1.

the product Y = X1. with moment generating function 1 MX ( t ) = 4 (1− 2500t ) Determine the standard deviation of the claim size for this class of accidents.660 176 Copyright ACTEX 2006 .340 (D) 10. Y is 1 if and only3 if all of the X i are 1.Solution: Since each X i can be only 0 or 1. X 2 .000 (B) 5. Thus 8 ⎛2⎞ P(Y = 1 = ⎜ ⎟ = ) 27 ⎝3⎠ 3 19 ⎛2⎞ P(Y = 0) = 1− P(Y = 1 = 1− ⎜ ⎟ = ) 27 ⎝3⎠ 19 0t 8 1t 19 8 t MY ( t ) = E ( e Yt ) = e + e = + e 27 27 27 27 Answer A 175 Exercise: An actuary determines that the claim size for a certain class of accidents is a random variable. (A)1.000 (E) 11. X. In addition. X 3 can be only 0 or 1.180 (C) 8.

000 σ X = V ( X ) = 25. 0002 = 25. 000. 000. 000 − 10.: MX ′ ( 0 ) = 10. 000 MX ′′ ( 0 ) = 125. 000. 000 = 5. 000. 000 V (X ) = E (X 2 ) − E (X ) 2 = 125. 000 (1− 2500t ) ( −2500 ) −5 = 125. 000 Answer B 178 Copyright ACTEX 2006 . 000 (1− 2500t ) −6 MX ′′ ( t ) = −50.Solution: Use the derivatives of the moment generating function to find the first two moments and thus 2 obtain V ( X ) = E ( X 2 ) − E ( X ) . 000. MX ( t ) = (1− 2500t ) −4 MX ′ ( t ) = −4 (1− 2500t ) ( −2500 ) −5 = 10. 000 (1− 2500t ) −5 177 Solution. cont.

560 (C) 5.760 180 Copyright ACTEX 2006 .320 (D) 8. cont.Exercise: A company insures homes in three cities. Calculate E ( X 3 ) . J. Since sufficient distance separates the cities.: Let X represent the combined losses from the three cities. (A)1. and L. it is reasonable to assume that the losses occurring in these cities are independent. The moment generating functions for the loss distributions of the cities are: −3 MJ ( t ) = (1− 2t ) MK ( t ) = (1− 2t ) ML ( t ) = (1− 2t ) −2.5 179 Exercise.082 (E) 10.5 −4. K.000 (B) 2.

: MX ′ ( t ) = −10 (1− 2t ) −11 ( −2) = 20 (1− 2t ) −13 −11 MX ′′ ( t ) = −220 (1− 2t ) −12 ( −2) = 440 (1− 2t ) −12 MX ′′′ ( t ) = −12 ( 440 )(1− 2t ) = 10. Note that X = J + K + L where summands are independent.5 −10 181 Solution. First find MX ( t ) . 560 (1− 2t ) −13 ( −2 ) E ( X 3 ) = MX ′′′ ( 0 ) = 10.Solution: Recall that E ( X 3 ) = MX ′′′ ( 0 ) . Thus MX ( t ) = M J+ K +L ( t ) = M J ( t ) M K ( t ) ML ( t ) = (1− 2t ) = (1− 2t ) −3 (1− 2t ) −2. cont.5 (1− 2t ) −4. 560 Answer E 182 Copyright ACTEX 2006 .

1. 184 Copyright ACTEX 2006 .Discrete Joint Probability Function: Definition: Let X and Y be discrete random variables. Note that: ∑∑ p(x. the dealer also tries to persuade the customer to buy an extended warranty for the car. y) = 1 x y Definition: The marginal probability functions of X and Y are defined by p X ( x) = ∑ p ( x . When selling a car. The joint probability function for X and Y is the function p(x . Let X denote the number of luxury cars sold in a given day. and let Y denote the number of extended warranties sold. y ) = P(X = x. Y = y ). y ) pY (y ) = ∑ p(x . y ) y x 183 Exercise: A car dealership sells 0. or 2 luxury cars on any day.

Y = 2) = 1/ 6 What is the variance of X? (A) 0.42 (E) 2. Y = 0) = 1/ 6 P(X = 1. X Y 0 1 2 0 1/6 0 0 1/6=2/12 1 1/12 1/6 0 3/12 2 1/12 1/3 1/6 7/12 186 pX ( x) Copyright ACTEX 2006 . Y = 0) = 1/12 P(X = 2.Exercise.58 185 Solution: First put the given information into a bivariate table and fill in the marginal probabilities for X.58 (C) 0.: P(X = 0. Y = 1 = 1/ 6 ) P(X = 2. cont. Y = 0) = 1/12 P(X = 1.47 (B) 0.83 (D) 1. Y = 1 = 1/ 3 ) P(X = 2.

cont.y.: ⎛ 2 ⎞ ⎛ 3⎞ ⎛ 7 ⎞ 17 E ( X ) = 0 ⎜ ⎟ + 1⎜ ⎟ + 2 ⎜ ⎟ = ⎝ 12 ⎠ ⎝ 12 ⎠ ⎝ 12 ⎠ 12 ⎛ 2 ⎞ ⎛ 3⎞ ⎛ 7 ⎞ 31 E ( X 2 ) = 0 2 ⎜ ⎟ + 12 ⎜ ⎟ + 22 ⎜ ⎟ = ⎝ 12 ⎠ ⎝ 12 ⎠ ⎝ 12 ⎠ 12 31 ⎛ 17 ⎞ V (X ) = − ⎜ ⎟ = . real valued function f(x.y) satisfying: i) f(x.y) ≥ 0 for all x.576 12 ⎝ 12 ⎠ 2 Answer B 187 Definition: The joint probability density function for two continuous random variables X and Y is a continuous. 188 Copyright ACTEX 2006 .Solution.

real valued function f(x.y) and the region in the x-y plane bounded by x = a . c≤ Y≤ d) is given by the volume between the surface z = f(x.y) satisfying: ii) The total volume bounded by the graph of z = f(x. y ) dy dx a c 190 b d Copyright ACTEX 2006 . P(a ≤ X ≤ b .y) satisfying: iii) P(a ≤ X ≤ b.∞ ∫ ∫ f(x. c ≤ Y ≤ d ) = ∫ ∫ f (x .y) and the x-y plane is 1.Definition: The joint probability density function for two continuous random variables X and Y is a continuous. ∞ ∞ −∞ . x = b. y = c and y = d. y) dx dy = 1 189 Definition: The joint probability density function for two continuous random variables X and Y is a continuous. real valued function f(x.

is f(s.y) be the joint density function for the continuous random variables X and Y. where 0 < s <1 and 0 < t <1 . What is the probability that the device fails during the first half hour of operation? 192 Copyright ACTEX 2006 . The device fails if either component fails. y)dy −∞ ∫ f(x. The joint density function of the lifetimes of the components. y)dx 191 Exercise: A device contains two components. measured in hours.t).Definition: Let f(x. The marginal distribution functions of X and Y are defined by: fX ( x ) = fY ( y ) = ∞ −∞ ∞ ∫ f(x.

Exercise.5 0 Solution: The device fails if either S < 1/ 2 or T < 1/ 2.5 0. t ) ds dt ∫∫ 0 1 0. cont.5 0 f ( s.5 0 f ( s.5 B . t ) ds dt 193 ∫ ∫ f ( s. t ) ds dt + ∫ ∫ 0.5 1 T 194 Copyright ACTEX 2006 .5 0 1 f ( s. t ) ds dt ∫ ∫ f ( s.5 0 f ( s.5 0.5 0.: (A) (B) (C) (D) (E) ∫ ∫ 0 0. t ) ds dt f ( s.5 1 0. S 1 A . t ) ds dt + ∫ 1 0 ∫ 1 0 0.5 1 0 1 ∫ ∫ 0 0. t ) ds dt 0.

000 ⎪0. t ) ds dt 0. t ) ds dt + ∫ ∫ f ( s . t ) ds dt + ∫∫ f ( s .: P ( S < 1/ 2 or Y < 1/ 2 ) = ∫∫ f ( s .5 Answer E 195 Exercise: The future lifetimes (in months) of two components of a machine have the following joint density function: ⎧ 6 ( 50 − x − y ) . 0 < x < 50 − y < 50 ⎪ f ( x . t ) ds dt A B 0. y ) = ⎨ 125.Solution.5 =∫ 0 ∫ f ( s . cont.5 0 0 1 1 0. otherwise ⎩ What is the probability that both components are still functioning 20 months from now? 196 Copyright ACTEX 2006 .

000 ∫20 ∫20 50 50− x − y 6 (E) ( 50 − x − y ) dy dx 125. Density function is non-zero only in the first quadrant triangle bounded above by the line x + y = 50 or y = 50 − x.Exercise. 000 50 50− x 6 (D) ( 50 − x − y ) dy dx 125. 000 ∫20 ∫20 197 Solution: Upper limits of integration in choices C and E are clearly incorrect. 000 ∫0 ∫0 30 50− x 6 ( 50 − x − y ) dy dx (B) 125. cont. 000 ∫20 ∫20 30 50− x − y 6 (C) ∫20 ∫20 ( 50 − x − y ) dy dx 125. We need P ( X ≥ 20 & Y ≥ 20 ) from A. B or D.: 20 20 6 (A) ( 50 − x − y ) dy dx 125. 198 Copyright ACTEX 2006 .

: P ( X ≥ 20 & Y ≥ 20 ) = ∫∫ f ( x.Solution.: In the diagram. we show the triangle and the region R where both components are still functioning after 20 months. y 50 20 R 50 x 20 30 199 Solution. 000 = Answer B 200 Copyright ACTEX 2006 . y ) dy dx R 30 50− x 6 ∫20 ∫20 ( 50 − x − y ) dy dx 125. cont. below. cont.

y ) = for 0 < x < 2 and 0 < y < 2 8 What is the probability that the device fails during its first hour of operation? (A) .625 (E) . y 2 B 1 A 1 2 x 202 Copyright ACTEX 2006 .391 (D) .y) for which this occurs is shown in the shaded region in the diagram below.Exercise: A device runs until either of two components fails. is x+y f ( x.141 (C) .875 201 Solution: The device fails if either X < 1 or Y < 1. The joint density function of the lifetimes of the two components. both measured in hours. The set of pairs (x. at which point the device stops running.125 (B) .

Solution, cont.: y 2

B

1

For the shaded region A, P ( X < 1 or Y < 1)

A

1 2

= ∫∫ f ( x , y ) dx dy

A

x

203

Solution, cont.: y 2

B 1 A 1 2

x

**Integrate over the unshaded rectangle B, to get the complementary probability. P ( X < 1 or Y < 1) = 1− ∫∫ f ( x , y ) dx dy
**

B

= 1− ∫

2

1

⎛x+y⎞ ∫1 ⎜ 8 ⎟ dx dy ⎝ ⎠

2

204

Copyright ACTEX 2006

Solution, cont.: y 2

B 1 A 1 2

⎛x+y⎞ ∫1 ∫1 ⎜ 8 ⎟ dx dy ⎝ ⎠ 2 2 2⎛ x ⎞ 1 = ∫ ⎜ + xy ⎟ dy 8 1⎝ 2 ⎠1 1 2 = ∫ (1.5 + y ) dy x 8 1 2 1⎛ 3 y2 ⎞ = ⎜ 1.5y + ⎟ = 8⎝ 2 ⎠1 8 = .375

2 2

205

Solution, cont.: y 2

B 1 A 1 2

x

P ( X < 1 or Y < 1) = 1− .375 = .625

Answer D

206

Copyright ACTEX 2006

Exercise:

A company is reviewing tornado damage claims under a farm insurance policy. Let X be the portion of a claim representing damage to the house and let Y be the portion of the same claim representing damage to the rest of the property. The joint density function of X and Y is ⎧ ⎡ ⎤ ⎪6 ⎣1- ( x + y ) ⎦ , x > 0, y > 0, and x+y < 1 f ( x, y ) = ⎨ otherwise ⎪0, ⎩

207

Exercise, cont.:

Determine the probability that the portion of a claim representing damage to the house is less than 0.2 .

(A) .360 (B) .480 (C) .488 (D) .512 (E) .520

208

Copyright ACTEX 2006

: y 1 A y = 1-x ∫∫ f ( x. y 1 y = 1-x A 1 .2 1− x 0 0 . cont.2 ) = ∫∫A f ( x . y ) dy dx where A is the region indicated in the diagram below. y ) dy dx = 6∫ ∫ [1− x − y ] dy dx A .2 1 x 210 Copyright ACTEX 2006 .Solution: Find P ( X < .2 x 209 Solution.

2 . y ) P(X = x |Y = y ) = p(x | y ) = .Solution. The conditional distribution of X given that Y=y is given by p (x . pY (y ) Continuous Case. fY (y ) 212 Copyright ACTEX 2006 .y).488 0 2 6 ⎢ ⎥0 ⎣ ⎦ Answer C Note: We can also work this using the marginal for X. cont. The calculations are basically the same. Let X and Y be continuous random variables with joint density function f(x.2 0 ∫0 [1− x − y ] dy dx = 6∫0 ⎜ y − xy − ⎝ .2 (1− x ) = 6∫ dx = 6 ⎢ ⎥ = . 211 y ⎞ dx 2 ⎟0 ⎠ 2 1− x Definitions: Discrete Case. The conditional density for X given that Y=y is given by f (x .2 1− x ⎛ 2 ⎛ (1− x ) ⎞ dx = 6∫ ⎜ (1− x ) − x (1− x ) − ⎟ 0 ⎜ 2 ⎟ ⎝ ⎠ .2 2 ⎡ − (1− x ) 3 ⎤ .: 6∫ . y ) f (x |Y = y ) = f (x | y ) = .

E(Y | X = x) = ∑ y p(y | x) E(X |Y = y ) = ∑ x p(x | y ) x y When X and Y are continuous.Conditional Expected Value: For discrete random variables.y). the conditional expected values are given by E(Y | X = x) = ∫ y f (y | x) dy −∞ ∞ ∞ E(X |Y = y ) = ∫ x f (x | y ) dx −∞ 213 Definitions: Two discrete random variables X and Y are independent if p(x . y ) = fX (x) fY (y ) for all pairs (x. y ) = p X (x) pY (y ) for all pairs of outcomes (x. 214 Copyright ACTEX 2006 .y). Two continuous random variables X and Y are independent if f (x .

and let Y denote the outcome of the diagnostic test.800 P(X = 1.025 P(X = 1.050 P(X = 0. cont. Y = 0) = 0.15 (C) 0.13 (B) 0.: The joint probability function of X and Y is given by: P(X = 0.20 (D) 0.51 (E) 0.71 216 Copyright ACTEX 2006 . Y = 1) = 0.Exercise: A diagnostic test for the presence of a disease has two possible outcomes: 1 for disease present and 0 for disease not present. Y = 1) = 0. Y = 0) = 0. 215 Exercise. (A) 0.125 Calculate Var( Y | X =1) . Let X denote the disease state of a patient.

175 218 Copyright ACTEX 2006 .175 pX ( x) 217 Solution.050 .05 = .800 .175 P (Y = 1& X = 1) P ( X = 1) .125 = . cont. X Y 0 1 0 .7143 .025 .825 1 .2857 .125 .Solution: We can calculate this variance if we know the conditional distribution of Y given that X=1.: P (Y = 0| X = 1) = = P (Y = 1| X = 1) = = P (Y = 0 & X = 1) P ( X = 1) .

2857 ( 0 ) + .2857 ( 0 ) + . the company makes an initial estimate.7143 − ( .7143 (1) = .: Use V (X ) = E ( X 2 ) − E ( X ) . X.7143 (1) = .Solution. y > 1 x ( x − 1) 220 Copyright ACTEX 2006 . of the amount it will pay to the claimant for the fire loss. cont.204 2 Answer C 219 Exercise: Once a fire is reported to a fire insurance company.7143 2 2 V ( X ) = . y ) = 2 y ( ) .7143 E (Y 2 | X = 1) = .7143 ) = . x > 1. to the claimant. The company has determined that X and Y have the joint density function ( 2 x −1) − 2 x −1 f ( x. When the claim is finally settled. Y. 2 E (Y | X = 1) = . the company pays an amount.

5y dy = 1 1 −4 −3 −3 .5y f ( y | X = 2) = = = 2y −3 fX ( 2 ) (1/ 4 ) P (1 < Y < 3| X = 2 ) = ∫ f ( y | X = 2 ) dy 3 1 3 3 ∞ = 1 1 4 Answer E = ∫ 2y −3dy = − y −2 = 1 1 8 9 222 Copyright ACTEX 2006 .5y . determine the probability that the final settlement amount is between 1 and 3. A) 1/9 B) 2/9 C) 1/3 D) 2/3 E) 8/9 221 Solution: To find P (1 < Y < 3| X = 2 ) we need: f ( 2.Exercise.5y −3 f ( y | X = 2) = = fX ( 2 ) fX ( 2 ) ∞ ∞ − y −2 −3 fX ( 2 ) = ∫ f ( 2.: Given that the initial claim estimated by the company is 2. y ) . cont. y ) dy = ∫ .

... n k ⎟ ⎝ ⎠ n1 ! n2 !. Let X i be the number of times that the outcome E i occurs in the n trials. E k .. n k ! 223 Review. n2 .. n2 ..Review: Counting Partitions: The number of partitions of n objects into k distinct groups of size n1.. Repeat this experiment in n independent trials. n k is given by n! n ⎛ ⎞ = ⎜ n1. p k nk ⎟ ⎝ n1.. n k ⎠ 224 Copyright ACTEX 2006 . P ( X1 = n1 & X 2 = n2 & . with P(E i ) = p i . .. cont..: The Multinomial Distribution: Random experiment has k mutually exclusive outcomes E1. .. … . & X k = n k ) n ⎛ ⎞ n1 n2 =⎜ p1 p 2 .. … . n2 .

the insurance company writes 4 new policies for adults earning their first driver’s license. an insurance company considers each driver to be randomly selected from the pool.006 (B) . 30% moderate-risk drivers.073 226 Copyright ACTEX 2006 . This month. cont. and 20% high-risk drivers.Exercise: A large pool of adults earning their first driver’s license includes 50% low-risk drivers. Because these drivers have no prior driving record.012 (C) .: What is the probability that these 4 will contain at least two more high-risk drivers than low-risk drivers? (A) .049 (E) .018 (D) . 225 Exercise.

4 ⎠ = 1( .30 p 3 = P(H) = .50 p 2 = P(M) = .1. cont.23 ) = .5 . moderate risk and high risk drivers respectively. and H: number of low risk. M. 3 ⎠ = 4 ( . 0.20 There are four cases: 227 Solution.: 1 2 ⎛ 4 ⎞ 0 0 4 P (L = 0 & M = 0 & H = 4) = ⎜ ⎟ .Solution: L.0096 228 Copyright ACTEX 2006 .3 .2 ⎝ 0.30.2 4 ) = .2 ⎝ 0.50.5 .3 .50.31. p1 = P(L) = .0016 ⎛ 4 ⎞ 0 1 3 P ( L = 0 & M = 1& H = 3 ) = ⎜ ⎟ .

50.2 ⎝ 1.5 .2 ⎝ 0.: 3 4 ⎛ 4 ⎞ 1 0 3 P ( L = 1& M = 0 & H = 3 ) = ⎜ ⎟ .0160 ⎛ 4 ⎞ 0 2 2 P ( L = 0 & M = 2 & H = 2) = ⎜ ⎟ .: The sum of these probabilities is .Solution.0488.5 .22 ) = . 0. cont.51.23 ) = .32.30. 3 ⎠ = 4 ( . 2 ⎠ = 6 ( .3 . Answer D 230 Copyright ACTEX 2006 .0216 229 Solution.3 . 2. cont.

Expected Value Properties: Sum of Two Random Variables: E(X + Y ) = E(X ) + E(Y ) Product of Two Random Variables: Discrete Case: E [(XY )] = ∑∑ (xy ) p(x . Y ) = E ⎡( X − μ X )(Y − μ Y ) ⎤ ⎣ ⎦ Alternative Calculation: Cov(X .E(X ) E(Y ) X and Y Independent: Cov(X . Y ) = 0 232 Copyright ACTEX 2006 . y ) dy dx 231 Product when X and Y Independent: E(XY ) = E(X ) E(Y ) Covariance Properties: Covariance of X and Y: Cov(X . Y ) = E(XY ) . y ) Continuous Case: ∞ E [(XY )] = ∫ x y −∞ −∞ ∫ ∞ xy f ( x .

Y ) Variance of X+Y when X and Y Independent: V (X + Y ) = V (X ) + V (Y ) 233 Useful Properties of Covariance: 1 2 3 4 5 Copyright ACTEX 2006 Cov(X . k) = 0. X ) Cov(X . Y ) = Cov(Y . Y + Z) = Cov(X .Variance Properties: Variance of X + Y: V (X + Y ) = V (X ) + V (Y ) + 2Cov(X . Cov(aX . X ) = V (X ) If k is a constant random variable. Y ) Cov(X . then Cov(X . Z) 234 . bY ) = ab Cov(X . Y ) + Cov(X .

− 1 ≤ ρ X .Y = Cov ( X .Y ≤ 1 235 Exercise: Let X and Y be the number of hours that a randomly selected person watches movies and sporting events. during a threemonth period. The following information is known about X and Y: E ( X ) = 50 E (Y ) = 20 Cov ( X . Y ) = 10 Var ( X ) = 50 Var (Y ) = 30 236 Copyright ACTEX 2006 . respectively.Correlation Coefficient: ρ X . Y ) σ Xσ Y .

(A) 0.Exercise. Let T be the total number of hours that these one hundred people watch movies or sporting events during this three-month period.87 (D) 0. Y ) = 50 + 30 + 2 (10 ) = 100 238 Copyright ACTEX 2006 . Approximate the value of P(T < 7100).: One hundred people are randomly selected and observed for these three months. For one individual. the total hours watching movies or sporting events is S = X + Y .92 (E) 0.97 237 Solution: A) Look at the total hours for a single individual B) Use the central limit theorem and normal approximation. cont.62 (B) 0. E ( S ) = E ( X + Y ) = E ( X ) + E (Y ) = 50 + 20 = 70 V ( S ) = V ( X + Y ) = V ( X ) + V (Y ) + 2Cov ( X .84 (C) 0.

x ≤ y ≤ 2x otherwise Calculate the covariance of X and Y. The total for all 100 people is T = S1 + . P ( T < 7100 ) = P ⎛ Z < ⎟ ⎜ 100 ⎝ ⎠ = P ( Z < 1) = .8413 Answer B 239 σ S = 10. + S100 . y ) = ⎨ 3 ⎪0 ⎩ for 0 ≤ x ≤ 1.04 (B) 0.25 (C) 0.Solution.. 000 7. 000 = 100 Exercise: Let X and Y be continuous random variables with joint density function ⎧8 ⎪ xy f ( x.100 − 7.: One hundred people are assumed iid.80 (E) 1. cont. T is approximately normal with E(T ) = μ T = 100(70) = 7. 000 V (T ) = σ T 2 = 100(100) = 10.24 240 Copyright ACTEX 2006 . 000 ⎞ Thus. By the central limit theorem. (A) 0..67 (D) 0.

Y ) = E ( XY ) − E ( X ) E (Y ) y 2 1 A y = 2x y=x 1 x 241 Solution.: 8 1 2x 2 2 E ( XY ) = ∫∫ xyf ( x . y )dydx = ∫ ∫ x y dy dx 3 0 x R 8 1⎡ 2 y 3 = ∫ ⎢x 3 0⎢ 3 ⎣ 1 2x x ⎤ 8 1⎛ 7 ⎞ ⎥ dx = ∫ ⎜ x 5 ⎟ dx 3 0⎝ 3 ⎠ ⎥ ⎦ 56 ⎛ x 6 ⎞ 56 = = 9 ⎜ 6 ⎟ 0 54 ⎝ ⎠ 242 Copyright ACTEX 2006 .Solution: Cov ( X . cont.

y ) dy dx = ∫ ∫ xy dy dx 3 0 x R 8 1⎡ y 3 = ∫ ⎢x 3 0⎢ 3 ⎣ 1 2x x ⎤ 8 1⎛ 7 ⎞ ⎥ dx = ∫ ⎜ x 4 ⎟ dx 3 0⎝ 3 ⎠ ⎥ ⎦ 56 ⎛ x 5 ⎞ 56 = = 9 ⎜ 5 ⎟ 0 45 ⎝ ⎠ 243 Solution.: E ( X ) = ∫∫ x f ( x . cont. y ) dy dx = R 2x 8 1⎡ 2 y 2 ⎤ = ∫ ⎢x ⎥ dx 3 0⎢ 2 x ⎥ ⎣ ⎦ 8 1⎛ 3 4 ⎞ = ∫ ⎜ x ⎟ dx 3 0⎝ 2 ⎠ 8 1 2x 2 ∫0 ∫x x y dy dx 3 ⎛x ⎞ 4 = 4⎜ ⎟ = ⎝ 5 ⎠0 5 5 1 244 Copyright ACTEX 2006 .: 8 1 2x 2 E (Y ) = ∫∫ y f ( x . cont.Solution.

: Cov ( X . and V(X+Y) = 8. E(X2) = 27.041 = Answer A 245 Exercise: X: Size of a surgical claim Y: Size of the associated hospital claim An actuary is using a model in which E(X) = 5.4. E(Y2) = 51. 246 Copyright ACTEX 2006 .Solution. Y ) = E ( XY ) − E ( X ) E (Y ) 56 4 ⎛ 56 ⎞ − ⎜ ⎟ 54 5 ⎝ 45 ⎠ = .4. E(Y) = 7. cont.

C2). C2 ) = Cov ( X + Y . Y ) = V (X ) + 2.4 − 7 2 = 2.1. Y ) + 1. cont.76 (D) 11. Calculate Cov(C1.2Y ) = V (X ) + 1.2Cov(X . X + 1. and let C2 denote the size of the combined claims after the application of that surcharge. Y ) 248 Copyright ACTEX 2006 . Y ) + Cov(X . X ) + Cov(Y .80 (B) 9. X ) + Cov(X .2Cov(Y .4 − 52 = 2.2V (Y ) V ( X ) = E ( X 2 ) − E(X )2 = 27.4 V ( X + Y ) = V ( X ) + V (Y ) + 2Cov ( X . Y ) + 1.60 (C) 9.32 247 Solution: C2 = X + 1.4 V (Y ) = E (Y 2 ) − E(Y )2 = 51.2Cov(X .2Y ) + Cov(Y .1. (A) 8.: Let C1 = X+Y denote the size of the combined claims before the application of a 20% surcharge on the hospital portion of the claim.2Y Cov(C1.52(E) 12.Exercise.2Y ) = Cov(X .

Cov(C1.4 + 2.2Cov(X . C2 ) = V (X ) + 2.4 ) = 8.4 + 2. Y ) + 1.: 8 = 2. Y ) = 1.2V (Y ) = 2.80 Answer A 249 Theorem: Double Expectation Theorem of the Mean: E[E(X |Y )] = E(X ) and E[E(Y | X )] = E(Y ) 250 Copyright ACTEX 2006 .2 (1.4 + 2Cov ( X .Solution. Y ) Cov ( X .2 ( 2.6 ) + 1.6 Now we have the required information. cont.

Exercise: An auto insurance company insures an automobile worth 15.02 chance of a total loss of the car.5003e − x / 2 f ( x) = ⎨ ⎩0 for 0 < x < 15 otherwise What is the expected claim payment? (A) 320 (B) 328 (C) 352 (D) 380 (E) 540 252 Copyright ACTEX 2006 .000 deductible. During the policy year there is a 0. 251 Exercise. the amount X of damage (in thousands) follows a distribution with density function ⎧0.04 chance of partial damage to the car and a 0.000 for one year under a policy with a 1. cont.: If there is partial damage to the car.

Solution: There are three possible cases.5003∫ ( x − 1) e − x / 2dx = 1.94 E ( Amount Paid|No Damage ) = 0 b) Full damage.04 (1.94 ( 0 ) + . Amounts are expressed in thousands.328 Answer B 254 = .04 − .02 = .2049 Copyright ACTEX 2006 . cont.04 E ( Amount Paid|Partial Damage ) =∫ 15 1 ( x − 1) f (x) dx 15 1 Expected amount paid in thousands . a) No damage. P ( No Damage ) = 1− .02 E ( Amount Paid|Total Loss ) = 15 − 1 = 14 253 Solution. P ( Total Loss ) = . P ( Partial Damage ) = .2049 ) = .: c) Partial damage.02 (14 ) + .

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