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Study Session: 2

LOS: 5.a

Interpret interest rates as required rate of return, discount rate, or opportunity cost.

Exam Probability: LOS 2.5.a

Low

Level I

© 2009 DeVry/Becker Educational Development Corp. All rights reserved.

Quantitative Methods

LOS: 2.5.a

The required rate of return is the minimum rate that an investor would require to earn before opting to commit to the investment. The discount rate is the rate that is used to find the present value of the investment. Opportunity cost is any value foregone by investing in the investment, such as the return on another investment that cannot be funded due to the commitment to the first investment.

Level I

© 2009 DeVry/Becker Educational Development Corp. All rights reserved.

Quantitative Methods

Study Session: 2

LOS: 5.b

Explain an interest rate as the sum of a real risk-free rate, expected inflation, and premiums that compensate investors for distinct types of risk.

Exam Probability: LOS 2.5.b

© 2009 DeVry/Becker Educational Development Corp. All rights reserved.

Low

Level I

Quantitative Methods LOS: 2.5. All rights reserved. Required Real Risk-free Expected Risk = + + Rate of Return Rate Inflation Premium Level I © 2009 DeVry/Becker Educational Development Corp.b Explain an interest rate as the sum of a real risk-free rate. . expected inflation. and premiums that compensate investors for distinct types of risk.

5. All rights reserved. given the stated annual interest rate and the frequency of compounding.c Calculate and interpret the effective annual rate. Medium Level I .c © 2009 DeVry/Becker Educational Development Corp.Quantitative Methods Study Session: 2 LOS: 5. Exam Probability: LOS 2.

given the stated annual interest rate and the frequency of compounding. i EAR = (1 + i p ) m −1 where: i EAR = Effective annual rate m = Number of periods per year i p = i APR / m = Periodic rate i APR = Stated annual interest rate Level I © 2009 DeVry/Becker Educational Development Corp.c Calculate and interpret the effective annual rate.5. .Quantitative Methods LOS: 2. All rights reserved.

All rights reserved. .c High Level I © 2009 DeVry/Becker Educational Development Corp.c Solve time value of money problems when compounding periods are other than annual. Exam Probability: LOS 2.Quantitative Methods Study Session: 2 LOS: 5.5.

All rights reserved. etc.5. use 4 times the periods and ¼ the rate. . m = number of compounding periods per year n = number of years np = mn = total number of periods i = annual discount rate ip = i/m = periodic rate * If payouts are made twice per year.c * Solve these problems using the total number of periods (np) and the periodic interest rate (ip). double the periods and half the rate.Quantitative Methods LOS: 2. Level I © 2009 DeVry/Becker Educational Development Corp. If quarterly payments.

Exam Probability: LOS 2.5.d High Level I © 2009 DeVry/Becker Educational Development Corp. .d Calculate and interpret the future value (FV) and present value (PV) of a single sum of money.Quantitative Methods Study Session: 2 LOS: 5. All rights reserved.

2. Clear your calculator. Steps to follow: 1.Quantitative Methods LOS: 2. .d Calculate and interpret the future value (FV) and present value (PV) of a single sum of money. All rights reserved. 3.5. Adjust interest rate (i) for compounding periods (n). Input variables (remember that PV and FV must have opposite signs). Level I © 2009 DeVry/Becker Educational Development Corp.

d Medium Level I © 2009 DeVry/Becker Educational Development Corp. Exam Probability: LOS 2. . All rights reserved.d Calculate and interpret the future value (FV) and present value (PV) of an ordinary annuity and an annuity due.5.Quantitative Methods Study Session: 2 LOS: 5.

Input variables (remember that PV and FV must have opposite signs). All rights reserved. Ordinary annuity (PMTs at end of each period) – End mode. .d Calculate and interpret the future value (FV) and present value (PV) of an ordinary annuity and an annuity due. 2. Steps to follow: 1.Quantitative Methods LOS: 2. Clear your calculator.5. Annuity Due (PMTs at beginning of each period) – Begin mode. 3. 4. 5. Adjust interest rate (i) for compounding periods (n). Level I © 2009 DeVry/Becker Educational Development Corp.

.d Calculate and interpret perpetuity (PV only). Exam Probability: LOS 2.5. All rights reserved.d Medium Level I © 2009 DeVry/Becker Educational Development Corp.Quantitative Methods Study Session: 2 LOS: 5.

All rights reserved.d Calculate and interpret perpetuity (PV only). PV0 = PMTp ip Level I © 2009 DeVry/Becker Educational Development Corp. .5.Quantitative Methods LOS: 2.

d Calculate and interpret a series of unequal cash flows. Exam Probability: LOS 2.d High Level I © 2009 DeVry/Becker Educational Development Corp.5. .Quantitative Methods Study Session: 2 LOS: 5. All rights reserved.

5.Quantitative Methods LOS: 2.d Calculator + + + = FV CF0(1+i)t CF1(1+i)t −1 CF2(1+i)t −2 CFn(1+i)t −n FVt CFt t n i = = = = + + + = PV CF1/(1+i)1 CF2/(1+i)2 CF3/(1+i)3 CFn/(1+i)n PV0 FV CF0 = 0 CF1 = CF2 = CFn = Compute NPV lump sum Now take PV to FV CF0 = Ø CF1 = CF2 = CFn = Compute NPV = Cash Flow at time t time number of periods rate Level I © 2009 DeVry/Becker Educational Development Corp. . All rights reserved.

and solve time value of money applications (for example. mortgages and savings for college tuition or retirement). All rights reserved.e Draw a time line. Medium Level I . Exam Probability: LOS 2.e © 2009 DeVry/Becker Educational Development Corp.Quantitative Methods Study Session: 2 LOS: 5.5.

e Draw a time line. and solve time value of money applications (for example. . mortgages and savings for college tuition or retirement). the monthly payment should be: Month 0 1 2 3 4 5 6 ip = 15%/12 = 1.Quantitative Methods LOS: 2.5.25 i 6 n = 174.03 1. All rights reserved. To pay off $1.25% HP: 1000 PV 0 FV PMT 1.03 Level I © 2009 DeVry/Becker Educational Development Corp.000 in credit card debt in 6 months at 15% interest.25 I/Y 6 N CF PV0 1000 PMT1 PMT2 PMT3 PMT4 PMT5 PMT6 0 TI: 1000 PV 0 FV CPT PMT = 174.

a Calculate and interpret the net present value (NPV) and the internal rate of return (IRR) of an investment.6. Exam Probability: LOS 2.Quantitative Methods Study Session: 2 LOS: 6. All rights reserved. .a High Level I © 2009 DeVry/Becker Educational Development Corp.

+ CFn (1 + r )n + . .6. The IRR measures the percentage return the investor will receive from the project. + CFn (1 + IRR ) (1 + IRR )2 CF2 (1 + IRR )n You can also use the Cash Flow functions of the financial calculator. Level I © 2009 DeVry/Becker Educational Development Corp. All rights reserved..Quantitative Methods LOS: 2..a NPV = CF0 + IRR = CF0 + (1 + r ) (1 + r )2 CF1 + CF1 + CF2 + . NPV measures the dollar amount by which investor wealth is increased through investing in the project... It is the discount rate that will produce a zero NPV.

Exam Probability: LOS 2.a Contrast the NPV rule to the IRR rule. All rights reserved.a High Level I © 2009 DeVry/Becker Educational Development Corp.6. .Quantitative Methods Study Session: 2 LOS: 6.

All capital budget projects with a positive NPV should be undertaken or.Quantitative Methods LOS: 2.a Contrast the NPV rule to the IRR rule. if they are mutually exclusive. Projects with an IRR that is greater than the required rate of return (cost of capital) should be undertaken. the one with the highest NPV should be accepted. All rights reserved. Level I © 2009 DeVry/Becker Educational Development Corp.6. .

6. Exam Probability: LOS 2. All rights reserved.a Medium Level I © 2009 DeVry/Becker Educational Development Corp.a Identify problems associated with the IRR rule.Quantitative Methods Study Session: 2 LOS: 6. .

. Level I © 2009 DeVry/Becker Educational Development Corp. Multiple sign changes in the cash flows create multiple IRRs for a single project. When evaluating mutually exclusive projects. IRR is a rate of return rather than an absolute dollar measure of wealth.6. NPV uses the more realistic assumption that all cash flows will be reinvested at the required rate of return. All rights reserved.a Identify problems associated with the IRR rule. The IRR assumes that all cash flows will be reinvested at the IRR. IRR might rank them differently than NPV.Quantitative Methods LOS: 2.

b High Level I © 2009 DeVry/Becker Educational Development Corp. calculate. .Quantitative Methods Study Session: 2 LOS: 6.b Define. Exam Probability: LOS 2. and interpret a holding period return (total return). All rights reserved.6.

A holding period is the time over which the investment's performance is being measured. dividends. Excess cash flows include capital appreciation. It measures the excess cash flow over the price paid for the investment.Quantitative Methods LOS: 2. interest. and interpret a holding period return (total return). etc. calculate. Level I © 2009 DeVry/Becker Educational Development Corp. The holding period return is the percentage return on an investment over a specified measurement period.6. rent.b Define. All rights reserved. .

All rights reserved.Quantitative Methods Study Session: 2 LOS: 6.6. . Exam Probability: LOS 2. and distinguish between the moneyweighted and time-weighted rates of return of a portfolio.c High Level I © 2009 DeVry/Becker Educational Development Corp. interpret.c Calculate.

c Calculate.. Rm-w = IRR R t-w = n (1 + r1 )(1 + r2 ) . (1 + rn ) − 1 Level I © 2009 DeVry/Becker Educational Development Corp.Quantitative Methods LOS: 2.. The money-weighted return is the investment's internal rate of return. All rights reserved. The timeweighted return is the geometric average return over the measurement period. . interpret.6. and distinguish between the money-weighted and time-weighted rates of return of a portfolio.

6. Exam Probability: LOS 2.Quantitative Methods Study Session: 2 LOS: 6.c High Level I © 2009 DeVry/Becker Educational Development Corp.c Appraise the performance of portfolios based on these measures. . All rights reserved.

Quantitative Methods LOS: 2. All rights reserved. Level I © 2009 DeVry/Becker Educational Development Corp.6. .c Appraise the performance of portfolios based on these measures. The money-weighted return is the IRR. The time-weighted return is the geometric average return and is not affected by cash flows into and out of the portfolio. It is affected by the amount and timing of cash flows into and out of the portfolio.

6. Exam Probability: LOS 2. and money market yield for a U. Medium Level I .d © 2009 DeVry/Becker Educational Development Corp. effective annual yield. holding period yield.Quantitative Methods Study Session: 2 LOS: 6. All rights reserved.d Calculate and interpret the bank discount yield. Treasury bill.S.

6. .d rBD = D ⎛ 360 ⎞ F⎜ t ⎟ ⎝ ⎠ EAY = (1 + HPY ) rmm 365 / t −1 P − P + D1 HPY = 1 0 P0 F = Face Value of the T-bill P1 = P rice received D 1 = Cash distibution received D = the discount from par value rM M = M oney m arket yield HPY = Effective period yield rBD = B ank discount yield P0 = Initial purchase price t = # of days to m aturity ⎛ 360 ⎞ = HPY ⎜ ⎟ ⎝ t ⎠ 360rBD 360 − (t)(rBD ) rmm = Level I © 2009 DeVry/Becker Educational Development Corp.Quantitative Methods LOS: 2. All rights reserved.

effective annual yields. Exam Probability: LOS 2.d Convert among holding period yields. and bond equivalent yields. money market yields.6. All rights reserved.Quantitative Methods Study Session: 2 LOS: 6. .d Medium Level I © 2009 DeVry/Becker Educational Development Corp.

All rights reserved. and bond equivalent yields. money market yields. ⎡ ⎛ t ⎞⎤ EAY = ⎢1 + rmm ⎜ ⎟⎥ ⎝ 360 ⎠ ⎦ ⎣ rmm 360 / t −1 BEY = 2 × Semiannual yield m ⎞ =⎛ ⎜ (1 + i ) 2 − 1⎟ × 2 ⎝ ⎠ P ⎛ 360 ⎞ t / 360 ⎡ = ⎢(1 + EAY ) − 1⎤ ⎜ ⎥⎝ t ⎟ ⎣ ⎦ ⎠ Level I © 2009 DeVry/Becker Educational Development Corp.6.Quantitative Methods LOS: 2. effective annual yields.d Convert among holding period yields. .

7.a Differentiate between descriptive statistics and inferential statistics. All rights reserved. Exam Probability: LOS 2. .a Low Level I © 2009 DeVry/Becker Educational Development Corp.Quantitative Methods Study Session: 2 LOS: 7.

7. Level I © 2009 DeVry/Becker Educational Development Corp. All rights reserved. . Inferential statistics are used to make predictions about a population. Descriptive statistics are used to organize and summarize data.Quantitative Methods LOS: 2.a Differentiate between descriptive statistics and inferential statistics.

Quantitative Methods Study Session: 2 LOS: 7. .a Differentiate between a population and a sample and among the types of measurement scales. Exam Probability: LOS 2.7. All rights reserved.a Low Level I © 2009 DeVry/Becker Educational Development Corp.

Quantitative Methods LOS: 2.a Population = all members of a group. Nominal scales categorize members of a group according to common characteristics. 3. 1.7. but also have a true zero point as the origin. but do not rank them. 4. members of a group are ranked on some basis. All rights reserved. In ordinal scales. Ratio scales have all of the characteristics of interval scales. Interval scales provide both a ranking and an assurance that the differences between scale values are equal. 2. . Sample = subset of a population. Level I © 2009 DeVry/Becker Educational Development Corp.

b Low Level I © 2009 DeVry/Becker Educational Development Corp. .Quantitative Methods Study Session: 2 LOS: 7. All rights reserved.7. Exam Probability: LOS 2.b Explain the concepts of a parameter and a sample statistic.

mode.b Explain the concepts of a parameter and a sample statistic. Parameter = Measures that describe the characteristics of a population (mean. median.Quantitative Methods LOS: 2. All rights reserved. Level I © 2009 DeVry/Becker Educational Development Corp. Sample Statistic = Measures that describe the characteristics of a sample. . variance).7.

b Explain the concept of a frequency distribution. All rights reserved. Exam Probability: LOS 2.b Medium Level I © 2009 DeVry/Becker Educational Development Corp.Quantitative Methods Study Session: 2 LOS: 7. .7.

. Of the 95 stocks in this group.b Explain the concept of a frequency distribution. .Quantitative Methods LOS: 2. 10 stocks had P/E ratios from 0 to 10. P/E Ratios 0 to 10 10 to 20 20 to 30 30 to 40 Frequency 10 40 30 15 Level I © 2009 DeVry/Becker Educational Development Corp. All rights reserved. 40 had P/E ratios of 10 to 20..7. A tabular display of data organized into groups or intervals with the number of observations appearing in each interval.

Exam Probability: LOS 2.c Medium Level I © 2009 DeVry/Becker Educational Development Corp.c Calculate and interpret relative frequencies and cumulative relative frequencies.7. All rights reserved.Quantitative Methods Study Session: 2 LOS: 7. given a frequency distribution. .

65 (0.40 35/100 = 0.00 Cumulative Relative Frequency 0.c P/E Ratio 0 to 10 10 to 20 20 to 30 Absolute Frequency 25 40 35 N = 100 Relative Frequency 25/100 = 0.35) Relative frequency = Absolute frequency Total # of observations Cumulative relative Sum of the = frequency relative frequency Level I © 2009 DeVry/Becker Educational Development Corp.25 40/100 = 0.4) 1.Quantitative Methods LOS: 2.00 (0. .65 + 0.7.35 1.25 0. All rights reserved.25 + 0.

Exam Probability: LOS 2.7.c Low Level I © 2009 DeVry/Becker Educational Development Corp. All rights reserved.c Describe the properties of a dataset presented as a histogram or a frequency polygon. .Quantitative Methods Study Session: 2 LOS: 7.

.30 Frequency 25 40 35 35 30 25 0 10 20 Interval 30 Frequency 35 30 25 0 10 20 Interval 30 Level I © 2009 DeVry/Becker Educational Development Corp.c Histograms and frequency polygons are graphic representations of frequency distributions.Quantitative Methods LOS: 2.7. 40 40 Frequency P/E Ratio 0 – 10 10 – 20 20 . All rights reserved.

High Level I . including the population mean. harmonic mean.Quantitative Methods Study Session: 2 LOS: 7. median.d © 2009 DeVry/Becker Educational Development Corp. Exam Probability: LOS 2. geometric mean.7. All rights reserved. and mode.d Define. and interpret measures of central tendency. arithmetic mean. weighted average or mean (including a portfolio return viewed as a weighted mean). sample mean. calculate.

d Population Mean (μx ) Sample Mean = = = = = n i =1 ∑ xi N ∑ xi n Weighted Mean = ∑ wiXi i=1 N+1 2 n (X) Median = Value of the th item in arrayed data Arithmetic Mean Geometric Mean (GX) Harmonic Mean μX = X N Mode = Most frequently occurring value in data 1/ N (X1)(X2)(X3 ). All rights reserved.Quantitative Methods LOS: 2.(XN)] n ∑ (1/ X ) i Level I © 2009 DeVry/Becker Educational Development Corp.... .(XN) = [(X1)(X2 )(X3 )..7.

.e Low Level I © 2009 DeVry/Becker Educational Development Corp. Exam Probability: LOS 2.Quantitative Methods Study Session: 2 LOS: 7.7.e Describe. and interpret quartiles. and percentiles. calculate. deciles. All rights reserved. quintiles.

and 99 nontrivial percentiles. Quartiles contain four groupings. Level I © 2009 DeVry/Becker Educational Development Corp.7. any data set can be divided into 3 nontrivial quartiles. deciles. All rights reserved. and percentiles. and percentiles are other ways of describing the dispersion of data using arrayed data sets. 9 nontrivial deciles. quintiles.e Describe. and interpret quartiles. Quartiles. deciles contain ten. calculate. . deciles.Quantitative Methods LOS: 2. quintiles. quintiles contain five. and percentiles divide an arrayed data set into 100 equal groupings. Thus. 4 nontrivial quintiles.

Exam Probability: LOS 2.f Define.f © 2009 DeVry/Becker Educational Development Corp.Quantitative Methods Study Session: 2 LOS: 7. calculate. All rights reserved. and 2) the variance and standard deviation of a population and of a sample.7. Medium Level I . and interpret 1) a range and mean absolute deviation.

calculate. and interpret 1) a range and mean absolute deviation. and 2) the variance and standard deviation of a population and of a sample.f Define.Quantitative Methods LOS: 2.7. . 1) Range = n i =1 2) Xmax − Xmin ∑ Xi − μ X MAD X = Population: σ 2 = x n ∑(X i =1 n i − μX ) N 2 σX = σX 2 N Sample: s2 x ∑ ( X − X)2 i = i =1 n −1 sX = σx 2 Level I © 2009 DeVry/Becker Educational Development Corp. All rights reserved.

using Chebyshev's inequality. Exam Probability: LOS 2. High Level I .7.g Calculate and interpret the proportion of observations falling within a specified number of standard deviations of the mean.g © 2009 DeVry/Becker Educational Development Corp.Quantitative Methods Study Session: 2 LOS: 7. All rights reserved.

All rights reserved.Quantitative Methods LOS: 2. using Chebyshev's inequality.7. . The proportion of observations falling within K standard deviations of the mean is at least: 1 1− 2 K Level I © 2009 DeVry/Becker Educational Development Corp.g Calculate and interpret the proportion of observations falling within a specified number of standard deviations of the mean.

and interpret the coefficient of variation. calculate.h Medium Level I © 2009 DeVry/Becker Educational Development Corp. Exam Probability: LOS 2.Quantitative Methods Study Session: 2 LOS: 7.h Define. .7. All rights reserved.

Level I © 2009 DeVry/Becker Educational Development Corp. and interpret the coefficient of variation.Quantitative Methods LOS: 2. All rights reserved. Coefficient σ = x of μx Variation OR Sx x This is a relative measure of dispersion (risk).7. .h Define. calculate.

.h Medium Level I © 2009 DeVry/Becker Educational Development Corp. calculate. Exam Probability: LOS 2. All rights reserved. and interpret the Sharpe Ratio.h Define.Quantitative Methods Study Session: 2 LOS: 7.7.

calculate. Level I © 2009 DeVry/Becker Educational Development Corp.7. and interpret the Sharpe Ratio.h Define. Sharpe = RP − RF σP Ratio The Sharpe ratio measures excess return (return over the risk-free rate) relative to the standard deviation (risk) of the portfolio.Quantitative Methods LOS: 2. . All rights reserved.

.Quantitative Methods Study Session: 2 LOS: 7. Exam Probability: LOS 2.i Define and interpret skewness.7.i Medium Level I © 2009 DeVry/Becker Educational Development Corp. explain the meaning of a positively or negatively skewed return distribution. All rights reserved.

7. explain the meaning of a positively or negatively skewed return distribution. . All rights reserved.i Define and interpret skewness. The mean is being "pulled" off-center by extreme values (called outliers) at one end or the other. A skewed distribution is a distribution that is not symmetrical. M0 Md μ μ Md M0 .Quantitative Methods LOS: 2.Skewed Distribution Level I + Skewed Distribution © 2009 DeVry/Becker Educational Development Corp.

median. All rights reserved.Quantitative Methods Study Session: 2 LOS: 7. Exam Probability: LOS 2.7. and mode for a nonsymmetrical distribution. .i Medium Level I © 2009 DeVry/Becker Educational Development Corp.i Describe the relative locations of the mean.

Positively Skewed Distribution: μ > Md > Mo Negatively Skewed Distribution: μ < Md < Mo Level I © 2009 DeVry/Becker Educational Development Corp. . All rights reserved. median. and mode for a nonsymmetrical distribution.Quantitative Methods LOS: 7.i Describe the relative locations of the mean.

All rights reserved.7.j Define and interpret measures of sample skewness and kurtosis. Exam Probability: LOS 2.Quantitative Methods Study Session: 2 LOS: 7.j Low Level I © 2009 DeVry/Becker Educational Development Corp. .

.7. Excess kurtosis measures how much a distribution deviates from normal.0. Excess Kurtosis = K − 3 Level I © 2009 DeVry/Becker Educational Development Corp. All rights reserved. ⎥ kurtosis ⎢ (n − 1)(n − 2)(n − 3) ⎥ ⎢ ⎥ s4 ⎣ ⎦⎢ X ⎥ ⎥ ⎥ ⎢ ⎥ ⎦ ⎣ ⎦ A normal distribution has a kurtosis of 3.j Define and interpret measures of sample skewness and kurtosis.Quantitative Methods LOS: 2. ⎡ n ⎢ ∑ Xi − X ⎡ ⎤ ⎢ i=1 n Sample =⎢ Skewness ⎣ (n − 1)(n − 2) ⎥ ⎢ s3 ⎦⎢ X ⎢ ⎣ ( ) 3⎤ ⎡ n 4⎤ ⎥ ⎢ ∑ (Xi − X) ⎥ ⎤ ⎢ i =1 n(n − 1) ⎥ Sample = ⎡ ⎥.

an outcome.a Low Level I © 2009 DeVry/Becker Educational Development Corp. All rights reserved.8. mutually exclusive events. and exhaustive events. an event. .a Define a random variable.Quantitative Methods Study Session: 2 LOS: 8. Exam Probability: LOS 2.

Quantitative Methods LOS: 2. the other events in the same possible event set cannot occur. All rights reserved. or set of specified outcomes. and exhaustive events. An event is any particular outcome. an event. Sets of events can also be collectively exhaustive. mutually exclusive events. . meaning that a certain set of events describe all the outcomes that are possible. Random variables are variables whose quantifiable outcomes (or particular values) are uncertain.a Define a random variable. meaning that if one event in a set of possible events occurs. Sets of events can be mutually exclusive. an outcome. Level I © 2009 DeVry/Becker Educational Development Corp.8.

b Explain the two defining properties of probability.Quantitative Methods Study Session: 2 LOS: 8.8. All rights reserved. Exam Probability: LOS 2.b Medium Level I © 2009 DeVry/Becker Educational Development Corp. .

a) The probability of an event occurring. All rights reserved. P(E).b Explain the two defining properties of probability. Level I © 2009 DeVry/Becker Educational Development Corp. . b) The sum of any set of mutually exclusive and collectively exhaustive events must equal 1.8. must be between 0 and 1.Quantitative Methods LOS: 2.

Quantitative Methods

Study Session: 2

LOS: 8.b

Distinguish among empirical, subjective, and a priori probabilities.

Exam Probability:

LOS 2.8.b

Low

Level I

© 2009 DeVry/Becker Educational Development Corp. All rights reserved.

Quantitative Methods

LOS: 2.8.b

a) b) Empirical Probability = probability based on historical data. A Priori Probability = adjusted empirical probability.

**Empirical No. of times on event has occured in the past = probability Total # of observations
**

To take into account defined changes in relationships that have occurred over time. Subjective Probability = personal assessment of the "odds" of an event occurring, without reference to any particular historical data set.

Level I

© 2009 DeVry/Becker Educational Development Corp. All rights reserved.

c)

Quantitative Methods

Study Session: 2

LOS: 8.c

State the probability of an event in terms of odds for or against the event.

Exam Probability:

LOS 2.8.c

Medium

Level I

© 2009 DeVry/Becker Educational Development Corp. All rights reserved.

Quantitative Methods LOS: 2. . All rights reserved. Odds for event E occuring = P(E) 1 − P(E) 1 − P(E) P(E) Level I Odds against event E occuring = © 2009 DeVry/Becker Educational Development Corp.8.c State the probability of an event in terms of odds for or against the event.

Quantitative Methods

Study Session: 2

LOS: 8.d

Distinguish between unconditional and conditional probabilities.

Exam Probability:

LOS 2.8.d

Medium

Level I

© 2009 DeVry/Becker Educational Development Corp. All rights reserved.

Quantitative Methods

LOS: 2.8.d

Distinguish between unconditional and conditional probabilities. Unconditional probability does not depend on some prior event and is denoted P(A). Conditional probability is the probability that one event will occur given that another event has already occurred and is denoted P(A\B), or the probability of A given that B has already occurred.

Level I

© 2009 DeVry/Becker Educational Development Corp. All rights reserved.

Quantitative Methods

Study Session: 2

LOS: 8.e

Calculate and interpret the joint probability of two events.

Exam Probability:

LOS 2.8.e

Medium

Level I

© 2009 DeVry/Becker Educational Development Corp. All rights reserved.

All rights reserved. P(A and B) = P(AB) = P(A) P(B\A) P(B and A) = P(BA) = P(B) P(A\B) Level I © 2009 DeVry/Becker Educational Development Corp.Quantitative Methods LOS: 2.e Calculate and interpret the joint probability of two events.8. .

8.e Calculate and interpret the probability that at least one of two events will occur. given the probability of each and the joint probability of the two events.Quantitative Methods Study Session: 2 LOS: 8.e © 2009 DeVry/Becker Educational Development Corp. Exam Probability: LOS 2. All rights reserved. Medium Level I .

8.e Calculate and interpret the probability that at least one of two events will occur. P(A or B) = P(A) + P(B) – P(AB) Union Probability Level I © 2009 DeVry/Becker Educational Development Corp. All rights reserved. .Quantitative Methods LOS: 2. given the probability of each and the joint probability of the two events.

.8.e High Level I © 2009 DeVry/Becker Educational Development Corp. All rights reserved.Quantitative Methods Study Session: 2 LOS: 8. Exam Probability: LOS 2.e Calculate and interpret a joint probability of any number of independent events.

Quantitative Methods LOS: 2.e Calculate and interpret a joint probability of any number of independent events. Level I © 2009 DeVry/Becker Educational Development Corp.8. . All rights reserved. P(AB) = P(A) P(B) if A and B are independent.

Exam Probability: LOS 2.Quantitative Methods Study Session: 2 LOS: 8.f Medium Level I © 2009 DeVry/Becker Educational Development Corp.8. All rights reserved.f Distinguish between dependent and independent events. .

Conditional probability implies Dependence.f Distinguish between dependent and independent events.Quantitative Methods LOS: 2. Unconditional probability implies Independence. Level I © 2009 DeVry/Becker Educational Development Corp. the probability of Event A occurring is the same whether or not Event B has already occurred (and vice versa). All rights reserved. .8. If Events A and B are independent of each other.

.8.g High Level I © 2009 DeVry/Becker Educational Development Corp. using the total probability rule. Exam Probability: LOS 2.g Calculate and interpret.Quantitative Methods Study Session: 2 LOS: 8. All rights reserved. an unconditional probability.

8)(.2)(.40 $1.08 P(2..8)(.20 P(2\PS) = .g The best way to analyze total probability is by drawing an event diagram..6) = . .Quantitative Methods LOS: 2.12 .00 + GS) = (.00 + GS) = (.00 + PS) = (..9) = .80 P(3\GS) = .10 P(3.72 P(2..00\Poor Sales P(1 \ PS) = .1) = .8. .2)(.00 \ Good Sales Good Sales P(GS) = . $3.0 0 $2.00 + PS) = (.60 Level I © 2009 DeVry/Becker Educational Development Corp.90 $2.4) = . 1.00\Good Sales P(2\GS) = . All rights reserved.08 P(1..00\Poor Sales Poor Sales P(PS) = .

h Low Level I © 2009 DeVry/Becker Educational Development Corp. Exam Probability: LOS 2.8.h Explain the use of conditional expectation in investment applications. .Quantitative Methods Study Session: 2 LOS: 8. All rights reserved.

h Explain the use of conditional expectation in investment applications. P/E ratios. such as EPS. Conditional expectation can be used to develop probability distributions of conditioned expectations of financial data.8. sales per share. Level I © 2009 DeVry/Becker Educational Development Corp. All rights reserved. etc. earnings per share.Quantitative Methods LOS: 2. This enables the use of scenario analysis. . stock price volatility.

i Diagram an investment problem.i High Level I © 2009 DeVry/Becker Educational Development Corp. Exam Probability: LOS 2. . using a tree diagram.8. All rights reserved.Quantitative Methods Study Session: 2 LOS: 8.

60 $2.96 0. Suppose that Wall Street analysts have projected that there is a 40% chance that GAB EPS will be $2. and a 30% chance that the EPS will be $2.Quantitative Methods LOS: 2.00 = 0.i Diagram an investment problem. . All rights reserved.40 Level I © 2009 DeVry/Becker Educational Development Corp.00.84 +0. a 30% chance that the EPS will be $2. what is the expected EPS of GAB? 40% × 2. using a tree diagram.40.80.80 = 30% × 2.8.40 = 30% × 2.

8. .j High Level I © 2009 DeVry/Becker Educational Development Corp. Exam Probability: LOS 2.j Calculate and interpret covariance and correlation. All rights reserved.Quantitative Methods Study Session: 2 LOS: 8.

.8. Alternatively. Level I © 2009 DeVry/Becker Educational Development Corp. COVXY = rXYσXσY COVXY = σ XY = ∑ [Xi − E(X)][Y0 − E(Y)] i=1 N N Correlation ( rXY ) is a measure of the degree to which two variables relate to each other.Quantitative Methods LOS: 2. All rights reserved.j Covariance is the statistical measure of the degree to which two random variables move together.

8. variance.k © 2009 DeVry/Becker Educational Development Corp. High Level I . Exam Probability: LOS 2.Quantitative Methods Study Session: 2 LOS: 8. and standard deviation of a random variable and of returns on a portfolio. All rights reserved.k Calculate and interpret the expected value.

k E(RP) = w1 E(R1) + w2 E(R2) + .2σ1σ2 Level I © 2009 DeVry/Becker Educational Development Corp.Quantitative Methods LOS: 2. (2 asset portfolio) σP = w1 σ1 + w 2 σ2 + 2w1w 2 COV1. 2 2 2 2 2 2 2 2 2 . All rights reserved.2 = w1 σ1 + w 2 σ2 + 2w1w 2 r1. E(Ri) = the expected return on asset i..8.. + wn E(Rn) Where: w i= the proportion of the total portfolio represented by asset i.

8. All rights reserved. . Exam Probability: LOS 2.Quantitative Methods Study Session: 2 LOS: 8.l Low Level I © 2009 DeVry/Becker Educational Development Corp.l Calculate and interpret covariance given a joint probability function.

Quantitative Methods LOS: 2. Covariance measures the degree to which corresponding random variables move together in two different data sets. All rights reserved. COVXY = σ XY = ∑ P(XY)[Xi − E(X)][Yi − E(Y)] i=1 N Level I © 2009 DeVry/Becker Educational Development Corp.l Calculate and interpret covariance given a joint probability function. . Variance measures the dispersion of the individual data points in the population from the population's expected value (or arithmetic mean).8.

using Bayes' formula. .m Calculate and interpret an updated probability.Quantitative Methods Study Session: 2 LOS: 8. Exam Probability: LOS 2. All rights reserved.8.m Medium Level I © 2009 DeVry/Becker Educational Development Corp.

.Quantitative Methods LOS: 2. All rights reserved. Bayes' Theorem provides an approach to adjusting probabilities based on new information. P(AnBz ) P(An )P(Bz \ An ) P(An \ Bz ) = = P(Bz ) P(Bz ) Level I © 2009 DeVry/Becker Educational Development Corp.m Calculate and interpret an updated probability.8. using Bayes' formula.

n Medium Level I © 2009 DeVry/Becker Educational Development Corp.8. All rights reserved.Quantitative Methods Study Session: 2 LOS: 8.n Identify the most appropriate method to solve a particular counting problem. Exam Probability: LOS 2. .

All rights reserved. Number of ways r objects can be chosen from a total of n objects and the order does not matter (defects) = combination 4. Only finite outcomes use counting methods 2. .Quantitative Methods LOS: 2. Assign n members to n tasks = factorial 3.8.n 1. Number of ways r objects can be chosen from a total of n objects and the order matters = permutation Level I © 2009 DeVry/Becker Educational Development Corp.

8.n Medium Level I © 2009 DeVry/Becker Educational Development Corp.n Solve counting problems using the factorial notation. All rights reserved. Exam Probability: LOS 2. .Quantitative Methods Study Session: 2 LOS: 8.

Factorial notation is used to determine the number of ways n tasks can be assigned to n members.8. Factorial = n! = n(n – 1)(n – 2)… 5! = 5 x 4 x 3 x 2 x 1 = 120 Level I © 2009 DeVry/Becker Educational Development Corp. . All rights reserved.Quantitative Methods LOS: 2.n Solve counting problems using the factorial notation.

Exam Probability: LOS 2. .Quantitative Methods Study Session: 2 LOS: 8.n Solve counting problems using the combination notation. All rights reserved.8.n Low Level I © 2009 DeVry/Becker Educational Development Corp.

Quantitative Methods LOS: 2. Combination notation is used to determine the number of ways that r items can be chosen from a total of n items.8. . n! ⎛n⎞ Combination = n Cr = ⎜ ⎟ = r ⎠ (n − r)!r! ⎝ Level I © 2009 DeVry/Becker Educational Development Corp.n Solve counting problems using the combination notation. All rights reserved. when the order does not matter.

8. .n Low Level I © 2009 DeVry/Becker Educational Development Corp. Exam Probability: LOS 2.n Solve counting problems using the permutation notation. All rights reserved.Quantitative Methods Study Session: 2 LOS: 8.

Permutation notation is used to determine the number of ways that r items can be selected from a total of n items. All rights reserved. n! Permutation = n Pr = (n − r)! Level I © 2009 DeVry/Becker Educational Development Corp. . when the order does matter.n Solve counting problems using the permutation notation.8.Quantitative Methods LOS: 2.

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