ero Quantitative Methods a PROBABILITY CONCEPTS CoN Try)(a IT Te Re) sae Ue) LOS : Define a random variable, an outcome, and an event. LOS : Identify the two defining properties of probability, including mutually exclusive and exhaustive events, and compare and contrast empirical, subjective, and a priori probabilities LOS : Describe the probability of an event in terms of odds for and against the event LOS : Calculate and interpret conditional probabilities LOS : Demonstrate the application of the multiplication and addition rules for probability LOS : Compare and contrast dependent and independent events LOS : Calculate and interpret an unconditional probability using the total probability ruleLearning Objectives (2/2) LOS : Calculate and interpret the expected value, variance, and standard deviation of random variables LOS : Explain the use of conditional expectation in investment applications LOS : Interpret a probability tree and demonstrate its application to investment problems LOS : Calculate and interpret the expected value, variance, standard deviation, covariances, and correlations of portfolio returns LOS : Calculate and interpret the covariances of portfolio returns using the joint probability function S : Calculate and interpret an updated probability using Bayes’ formula LOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation conceptsLOS : Define a random variable, an outcome, and an event @ Arandom variable refers to any quantity with uncertain expected future values. > Example: The rate of return earned on a stock next year, the value of the S&P 500 index a year from today, or the time of death of an individual in a life insurance contract. © An outcome refers to any possible value that a random variable can take. > Example: A lottery ticket has two outcomes — a win or a loss; or > The return earned by a mutual fund can take on any value around a specific mean expectation. @ An event is a specified outcome or a specified set of outcomes. > For example, we could define event A as the event when the return earned by a mutual fund is 10% or less, and event B as the event when the return is more than 10%.LOS : Identify the two defining properties of probability, including mutually exclusive and exhaustive events, and compare and contrast empirical, subjective, and a priori probabilities Tera tu cee ated Anumber between 0 and 1 that measures the chance that a stated event will occur. If there is a 0.6 probability that a portfolio will earn a return below 10%, there is a 60% chance of that event happening. If an event is certain to occur its probability is 1 (100%). If an event is impossible, its probability is 0. WER RR Ua ee) Le Bgl Ll g The probability of any event E is a number between 0 and 1: 0 < P(E) <1. The sum of the probabilities of any set of mutually exclusive and exhaustive events equals 1.LOS : Identify the two defining properties of probability, including mutually exclusive and exhaustive events, and compare and contrast empirical, subjective, and a priori probabilities Ifa list of events is mutually exclusive, it means that only one of them can possibly take place at atime. Event A: Return on a stock = 10% Event B: Return on a stock is < 10% Ifa list of events are exhaustive, it means they cover all possible outcomes. They incorporate all potential outcomes. claret Event A: Return on a stock = 10% Event B: Return on a stock is < 10% Event C: Return on a stock is > 10%LOS : Identify the two defining properties of probability, including mutually exclusive and exhaustive events, and compare and contrast empirical, subjective, and a priori probabilities Probabilities can be: © Anempirical probability is a probability that results from analyzing actual past data. > Example: Analyzing return data of the past 20 years to estimate the return on a stock next year. Subjective probabilities usually reflect personal belief or judgment. > Analysts may rely on their personal experience and judgment when estimating future performance. Apriori probabilities are deductive and based on reasoning. > Example: If there are only two applicants for a job, and candidate A has a 70% of sailing through, we can conclude that candidate B has a 30% of getting the job.LOS : Describe the probability of an event in terms of odds for and against the event Odds for and against an event represent a ratio of the desired outcomes versus the field. The odds for an event are the ratio of the number of ways the event can occur to the number of ways the event does not occur. Thus: > Given the probability of an event ‘E’ ie., P(E), P(E) Odds for E = T-PE} > Given odds for E of “a to b,” the implied probability of E is a The odds against an event are the ratio of the number of ways the event cannot occur to the number of ways the event can occur. ; _ {1-P®)} Odds against E = 75H > Given odds against E of “a to b,” the probability of E is >. eyLOS : Describe the probability of an event in terms of odds for and against the event After analyzing historical performance, an analyst believe that a stock’s EPS will range from $0.20 to $0.35 next year, and that the odds for the stock beating the highest estimate, $0.35, are 1 to 9. What is the probability that the stock will actually beat the highest estimate?LOS : Describe the probability of an event in terms of odds for and against the event After analyzing historical performance, an analyst believe that a stock’s EPS will range from $0.20 to $0.35 next year, and that the odds for the stock beating the highest estimate, $0.35, are 1 to 9. What is the probability that the stock will actually beat the highest estimate? a a b 6 Define event E as the stock beating the highest estimate: 1 por 0.1 1 P@) =T 9 > io Interpretation: Out of 10 cases in total, we expect the stock to beat the highest estimate just once.JS : Demonstrate the application of the multiplication and addition rules for probability & Aconditional probability describes the probability of an event ‘A’ given that another event ‘B’ has already occurred. > We pronounce P(A | B) as “the probability of A given B.” > Example: The probability that a stock earns a 10% annual return, given that, it has earned a 9% return during each of the two previous years. P(AB) P(A) P(AB) PIB) = Fe) or POBIA) =LOS : Demonstrate the application of the multiplication and addition rules for probability rea ‘@® We use the multiplication rule to determine the joint probability of two events, P(AB). > Ajoint probability is the probability of two events happening together. > For example, we may be interested in the probability that both gas prices and bus fare increase at the same time. > The multiplication rule states that: P(AB) = P(A|B) P(B) ‘@® However, if A and B are independent events, P(AB) = P(A) P(B) > Aand B are independent if whether or not event B has occurred gives us no information on whether A has occurred.LOS : Demonstrate the application of the multiplication and addition rules for probability oe A bag contains 16 blue balls and 14 yellow balls. Two balls are drawn from the bag at random, one after the other without replacement. What will be the joint probability of both balls being blue?LOS : Demonstrate the application of the multiplication and addition rules for probability ee A bag contains 16 blue balls and 14 yellow balls. Two balls are drawn from the bag at random, one after the other without replacement. What will be the joint probability of both balls being blue? a o 0 The probability that the first ball to be drawn is blue, P(A), is 16/30. The probability that the second ball to be drawn is blue given the first one is also blue, P(B|A), is 15/29. P(AB) = P(B| A)xP(A) 15/29x16/30 27.59%LOS : Demonstrate the application of the multiplication and addition rules for probability P(A) P(B) For mutually exclusive events, P(AorB) = P(A) + P(B) ® For non-mutually exclusive events, we avoid double-counting the outcomes in the intersection of A and B by subtracting P(AB): P(AorB) = P(A) + P(B)- P(AB)LOS : Demonstrate the application of the multiplication and addition rules for probability ee ACFA candidate is asked two questions. The probability that she gets the first question correct is 0.3, and the probability that she gets the second question correct is 0.4, Given that the probability that she gets both questions correct is 0.1, what is the probability that she gets either the first, the second, or both questions right?JS : Demonstrate the application of the multiplication and addition rules for probability ee ACFA candidate is asked two questions. The probability that she gets the first question correct is 0.3, and the probability that she gets the second question correct is 0.4, Given that the probability that she gets both questions correct is 0.1, what is the probability that she gets either the first, the second, or both questions right? a a P(A) = 0.3; P(B) = 0.4; and P(AB) = 0.1 P(A or B) = P(A) + P(B) — P(AB) P(A or B) = 0.3 +04-0.1=0.6LOS : Compare and contrast dependent and independent events ©, Two or more events are independent if the occurrence of one event has no influence on the occurrence of the other event(s). © Putting this in annotations: P(A|B) = P(A) or P(B/A) = P(B) Independent events Pea eu eas Suppose you rolled a dice and flipped If you draw a blue ball without acoin. The probability of getting any replacing it, the probability of drawing number face on the die does not another blue ball in your second influence the probability of getting a attempt is greatly changed because you head or a tail on the coin. drew a blue ball the first time.LOS : Demonstrate the application of the multiplication and addition rules for probability See Abag contains 16 blue balls and 14 yellow balls. Two balls are drawn from the bag at random, one after the other without replacement. What will be the joint probability of both balls being blue? o o 6 The probability that the first ball to be drawn is blue, P(A), is 16/30. The probability that the second ball to be drawn is blue given the first one is also blue, P(B|A), is 15/29. P(AB) = P(B| A)xP(A) 15/29x16/30 27.59%LOS : Compare and contrast dependent and independent events ©, Two or more events are independent if the occurrence of one event has no influence on the occurrence of the other event(s). ©, Putting this in annotations: P(A|B) = P(A) or P(B| A) = P(B) Independent events Pea eue ea Suppose you rolled a dice and flipped If you draw a blue ball without acoin. The probability of getting any replacing it, the probability of drawing number face on the die does not another blue ball in your second influence the probability of getting a attempt is greatly changed because you head or a tail on the coin. drew a blue ball the first time.LOS : Calculate and interpret an unconditional probability using the total probability rule & Unconditional probability (also known as marginal probability) is the probability that an event occurs without taking into account any other preceding events. > Unconditional probabilities are not conditioned on the occurrence of any other events; they are ‘stand-alone’ events. > Example: The probability that a given stock earns a 10% annual return, annual returns. ‘/ The total probability rule explains an unconditional probability of an event, in terms of that event's conditional probabilities in a series of mutually exclusive, exhaustive scenarios. P(A) = P(A|S)xP(S) + P(A] S°)xP(S°) Where S¢ is the complement of S. z=LOS : Calculate and interpret an unconditional probability using the total probability rule We have been given the following probabilities regarding the economic state and a given stock performance: Lgl s aol Stock Eyer f ota eine ee errr) Creu cis} Poueaue ute’ No recession 07 Rise P(SR | R°) PR) Fall P(SR°| R°) 0.2 Recession = Rise P(SR |R) 03 P(R) . Fall P(SR°|R) 07 What is the total probability of a stock rise?LOS : Calculate and interpret an unconditional probability using the total probability rule We have been given the following probabilities regarding the economic state and a given stock performance: Peer iad Berd Serre Cree} ea No recession PR) Fall P(SRE} RS) Recession P(R) What is the total probability of a stock rise? a 6 P(SR) = P(SR [R®) P(R®) + P(SR | mye = 0.8%0.7 + 0.3x0.3 = 0.65LOS : Calculate and interpret the expected value, variance, and standard deviation of random variables The expected value of a random variable is the probability-weighted average of the possible outcomes of the random variable. For a random variable X, the expected value is denoted as E(X). BCX) = POX IK: + PCKa)Xe + + POn)Xa =) PORK: : The variance of a random variable is the expected value (the probability- weighted average) of squared deviations from the random variable’s expected value. o?(X) = Ef{[X — E(X)]*} Standard deviation is the positive square root of variance. Standard deviation is easier to interpret than variance, as it is in the same units as the random variable. —_>LOS : Calculate and interpret the expected value, variance, and standard deviation of random variables S—__ The probability distribution of a company’s sales is as follows: ered Beanies) 50 0.20 0.30 40 0.50 What is the standard deviation of sales? a 6 First, calculate the expected sales: E(sales) = 0.250 + 0.3x40 + 0.5x0.3 = $37 millionLOS : Calculate and interpret the expected value, variance, and standard deviation of random variables SE __ The probability distribution of a company’s sales is as follows: erry Sone) 0.20 50. 0.30 40 0.50 30 What is the standard deviation of sales? a Oo Second, calculate variance of sales, a? (sales): 6? = P($50)[$50 — E(sales)]* + P($40)[$40 — E(sales)]? + P($30) [$30 — E(sales) |? = 0.2(13?) + 0.3(3?) + 0.5(—7?) = $61 millionLOS : Calculate and interpret the expected value, variance, and standard deviation of random variables —SE——__ The probability distribution of a company’s sales is as follows: eres Beaman) 50 0.20 0.30 40 0.50 What is the standard deviation of sales? a 6 The standard deviation of sales is thus ¥ $61 million = $7.81 millionLOS : Explain the use of conditional expectation in investment applications Conditional expectation in the context of investments refers to the expected value of an investment given a certain set of real-world events that are relevant to that particular investment. The expected value of an investment is affected by the actions of competitors, governments, and other financial institutions. The total probability rule is very useful when determining the unconditional expected value of an investment. The unconditional expected value, E(X), is the sum of conditional expected values. Thus, BQ) =)" EtXI5)P(5) Cn Cr eer u ks aetna recur urs Ca i:LOS : Explain the use of conditional expectation in investment applications There is a 20% chance that the government will impose a tariff on imported cars. A company that assembles cars locally expects returns of 14% if the tariff is imposed and returns of 11% if the tariff is not imposed. What is the (unconditional) expected return?LOS : Explain the use of conditional expectation in investment applications There is a 20% chance that the government will impose a tariff on imported cars. A company that assembles cars locally expects returns of 14% if the tariff is imposed and returns of 11% if the tariff is not imposed. What is the (unconditional) expected return? ra bs EQ) =) EXIS)PIS) i=1 = 0.11(0.8) + 0.14(0.2) = 0.116 or 11.6%LOS : Interpret a probability tree and demonstrate its application to investment problems @ Atree diagram is a visual representation of all possible future outcomes and the associated probabilities of a random variable. @ Each branch in a tree diagram represents an outcome. > Example: Tossing a fair coin twice. Note the following: os 7H HH 0.25 ae |. The tree diagram must include all — possible outcomes. OTT . |. The sum of the probabilities must add upto 1. oy |. The number of branches represents the number of different possibilities. H H 3 BN - PCos . Probabilities are represented by the numbers on the branches. first toss secondtoss outcomes probabilityLOS : Interpret a probability tree and demonstrate its application to investment problems ———————_ Suppose the prospects for recovering principal for a defaulted bond issue depend on which of two economic scenarios prevails. = Scenario 1 has a probability of 0.60 and will result in recovery of $0.80 per $1 principal value with a probability of 0.35, or in recovery of $0.70 per $1 principal value with a probability 0.65. ® Scenario 2 has a probability of 0.40 and will result in recovery of $0.60 per $1 principal value with a probability of 0.70, or in recovery of $0.30 per $1 principal value with a probability of 0.30. The expected recovery is closest to:LOS : Interpret a probability tree and demonstrate its application to investment problems Recovery = $0.80 Probability = 0.21 Scenario 1 Recovery = $0.70 Scenario 2 E(recovery | scenario 1) = 0.35($0.80) + 0.65($0.70) = $0.735 E(recovery | scenario 2) = 0.70($0.60) + 0.30($0.30) = $0.51 E(recovery) = 0.60($0.735) + 0.40($0.51) = $0.645S : Calculate and interpret the expected value, variance, standard deviation, covariances, and correlations of portfolio returns \@ The expected return on a portfolio is a weighted average of the expected returns on the component securities. 6 6 E(R) = w,R, + w2R2 +...+ WaRyS : Calculate and interpret the expected value, variance, standard deviation, covariances, and correlations of portfolio returns \® The variance of a portfolio's return is a function of the variance of the component assets as well as the covariance between each of them. > Ina two-asset portfolio with assets AandB, O oO o7(Rp) = waxo7(Ra) + wgxo7(Rp) + 2x(wa)x(Wp)xCov(Ra, Rp) Where: wa and wg are portfolio weights, o*(Ra) and o2(Rp) PRE Se eee eure ©, The standard deviation of a portfolio is the square root of portfolio variance.LOS : Calculate and interpret the expected value, variance, standard deviation , covariances, and correlations of portfolio returns You have a portfolio of two mutual funds, A and B, where 60% is invested in A and 40% invested in B, and the Cov(R,,Rg) is equal to 0.0144. Further information of both funds is shown below: E(R) 15% 10% Standard deviation of returns (0) —— What is the portfolio’s expected return and standard deviation of returns? EELOS : Calculate and interpret the expected value, variance, standard deviation , covariances, and correlations of portfolio returns foe Ra E(R) = waRq + waRp = 0.6(15%) + 0.4(10%) = 13% Portfolio variance: o?(R,) = waxo7(Ra) + wgxo?(Rg) + 2x(Wa)x(Wg)xCov(Ra, Rg) = 0.67(0.2)? + 0.47(0.15)? + 2(0.6)(0.4) (0.0144) = 0.024912 OCU CC Ra UcLiC o(Rp) = V0.024912 = 15.78%LOS : Calculate and interpret covariance and correlation given a joint probability function Covariance is a measure of the degree of co-movement between two random variables. For instance, we could be interested in the degree of co-movement between interest rates and inflation. b é var[Y] = E[(Y — Ely) — Ely] cov[X,¥] = E[(K — E[X)(¥ — ElY])]LOS : Calculate and interpret covariance and correlation given a joint probability function \® The covariance of returns from a joint probability model is based on the probability-weighted average of the cross-products of the random variables’ deviations from their expected values for each possible outcome. \e,_ If we have two assets, | and J, with returns Rj and R; respectively, 6 0 oe 2 P(RDIR: — E(RDI[R, - E(R;)]LOS : Calculate and interpret covariance and correlation given a joint probability function A portfolio manager is considering the following two possible economic growth of a country and the joint variability of returns on two stocks in a portfolio eRe hil) Probability 40% Return of Stock A 2.3% Return of Stock B 6.5% Se What is the covariance between the return of stock A and stock B? eeLOS : Calculate and interpret covariance and correlation given a joint probability function Expected return of Stock A = (40% x 2.3%) + (60% x 8%) = 5.72% Expected return of Stock B = (40% x 6.5%) + (60% x 3%) = 4.40% Delay Cle os Economic Pea 2.3 - 5.72 8—- 5.72 ‘Note: This is how itis shown in your curriculum by removing the % signs. rT are) bare) las Crea ay mm Cela a) ees eed Tail deviations as Po ees 65- 44 —7.182 3-44 —3,192LOS : Calculate and interpret covariance and correlation given a joint probability function EMC en eek & Positive covariance > Returns on both assets tend to be on the same side (above or below) their expected values at the same time (an average positive relationship between returns). @ Negative covariance > When the return on one asset is above its expected value, the return on the other asset tends to be below its expected value (an average inverse relationship between returns). & Zero covariance > Returns on the assets are unrelated.LOS : Calculate and interpret covariance and correlation given a joint probability function Correlation is the ratio of the covariance between two random variables and the product of their two standard deviations 6 oO ee Covariance (RjR;) orreration US'S) ~ Standard deviation R;xStandard deviation R;LOS : Calculate and interpret covariance and correlation given a joint probability function © Increasingly positive correlation > Strong positive linear relationship (up to 1, which indicates a perfect linear relationship). Increasingly negative covariance > Strong negative (inverse) linear relationship (down to -1, which indicates a perfect inverse linear relationship). Zero correlation > No linear relationship.LOS : Calculate and interpret covariance and correlation given a joint probability function An analyst is analyzing the impact of changes in interest rate by the Central Bank on the Country’s inflation rate. He analyzed historical data for five years. The covariance between interest rate and inflation is -0.00075 while the standard deviation of interest rate is 5.5% and inflation rate is 12%. aa ——__ Calculate and interpret the correlation between interest rate and inflation.LOS : Calculate and interpret covariance and correlation given a joint probability function An analyst is analyzing the impact of changes in interest rate by the Central Bank on the Country’s inflation rate. He analyzed historical data for five years. The covariance between interest rate and inflation is -0.00075 while the standard deviation of interest rate is 5.5% and inflation rate is 12%. Covariancejntine -0.00075 Standard deviationjn_XStandard deviationing Correlationintint = The correlation of -0.114 indicates that interest rate and inflation are negatively correlated with each other.LOS : Calculate and interpret covariance and correlation given a joint probability function ee Covariances can be represented in a square format in a covariance matrix as follows: A i] c Cov(Ra,Ra) Cov(Ra,Rp) — Cov(Ra, Rc) Cov(Rg,Ra) Cov(Rg,Rp) — Cov(Rp, Rc) Cov(Re,Ra) Cov(Rc,Rp) — Cov(Rc, Rc) > The off-diagonal terms represent variances since Cov(Rx, Rx) = Var(X). } Atwo-asset portfolio would have a similar 2 = 2 matrix. & Acorrelation matrix can also be created to represent the correlations between various assets in a portfolio.LOS : Calculate and interpret an updated probability using Bayes’ formula Bayes’ formula is used to calculate an updated/posterior probability given a set of prior probabilities for a given event. It’s a theorem named after the reverend T Bayes and is used widely in Bayesian methods of statistical influence. It allows us to ‘turn around’ conditional probabilities i.e. We can calculate P(E; | A) if given only information about P(A |E;). PCE))P(AIE:) i=1,2,3,..,n PEIN = 5 P(E) PAIB)LOS : Calculate and interpret an updated probability using Bayes’ formula P(E)) are known as prior probabilities. The event A is some event known to have occurred. |. P(E; | A) is the posterior probability.LOS : Calculate and interpret an updated probability using Bayes’ formula A Civil Engineer wishes to investigate the punctuality of electric trains by considering a number of train journeys. In the sample, 50% of trains had a destination for New York, 30% Vegas, and 20% Washington DC. The probabilities of a train arriving late in New York, Vegas and Washington DC are 40%, 35%, and 25% respectively. If the Engineer picks a train at random from this group, what is the probability that it terminated late in New York?LOS : Calculate and interpret an updated probability using Bayes’ formula V.. are looking for P(New York | Late). Let’s define the following events: i. Nis the event “A train chosen at random terminated in New York.” ii. Vis the event “A train chosen at random terminates in Vegas.” iii. Wis the event “A train chosen at random terminates in Washington DC.” Finally, let L be the event “A randomly chosen train arrives late.” P(N)PCLIN) P(N)P(LIN) + P(V)P(LIV) + P(W)P(L|W) _ 0.5x0.4 ~ 05x04 + 0.3X0.35 + 0.2x0.25 P(NIL) = = 0.5634 or 56.3%LOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation concepts ree Rta cls © Counting problems involve determining the exact number of ways two or more operations or events can be performed together. D> For instance, we might be interested in the number of ways we can choose 7 stocks comprising 3 small-cap and 4 large-cap stocks from a group of 50 stocks.LOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation concepts 1. Factorial Notation e, “n factorial” (n!) is used to represent the product of the first n natural ~~ numbers. Generally: o 0 0 n! = nx(n- 1)xX(n- 2)x(m- 3)x--x2x1 3l=3x2x1LOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation concepts 2. Labeling ©) The labeling principle is used to assign k labels/groups to a total of n items, where each label contains n; items such that n, + n, +73 +... + m = Nn. } In other words, your wish is to have n items categorized into k groups, where the number of items in each group is pre-determined. \®, To get the total number of ways that the labels/groups can be assigned, you use the formula: A 6 6 n! Ny XNz XN X XNLOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation concepts Assume that you have a portfolio of investments consisting of 10 stocks. Suppose your wish is to assign 3 different labels such that label 1 has 5 “high risk” stocks, label 2 has 3 “medium risk” stocks and the last label has 2 “low risk” stocks.LOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation concepts Assume that you have a portfolio of investments consisting of 10 stocks. Suppose your wish is to assign 3 different labels such that label 1 has 5 “high risk” stocks, label 2 has 3 “medium risk” stocks and the last label has 2 “low risk” stocks. a o te } n! ny XN2 XN X “-XNjc __10! © 5ixaixai = 2,520 waysLOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation concepts 3. Combinations \®, Acombination is basically a selection of some given items where the order does not matter. \& The number of combinations (possible ways) of n items taken r at a time is: a a 0 o n! ner = G@=oinLOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation concepts How many ways can we choose 3 stocks from a portfolio consisting of 10 stocks?LOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation concepts How many ways can we choose 3 stocks from a portfolio consisting of 10 stocks? n! @— DI tr ncr = 120 “Gol 313!LOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation concepts 4, Permutations © Unlike a combination, a permutation involves determining the number of possible ways to choose r items from n items where the order is paramount. O 0 , nt Number of permutations = nPr = colLOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation concepts How many ways can we choose 3 stocks from a portfolio consisting of 10 stocks in order to execute a sale, if the order of sale is paramount? o 6LOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation concepts How do you determine which approach to take? If you are asked to assign n items to n slots, use the factorial formula. In case you are asked to assign k unique labels or categories to n items, use the labeling formula. When asked to come up with the number of ways to choose r items from n items when the order is not important, use the combination formula. If the order is important, use the permutation formula.eS Te Re) sae Ue) LOS : Define a random variable, an outcome, and an event. LOS : Identify the two defining properties of probability, including mutually exclusive and exhaustive events, and compare and contrast empirical, subjective, and a priori probabilities LOS : Describe the probability of an event in terms of odds for and against the event LOS : Calculate and interpret conditional probabilities LOS : Demonstrate the application of the multiplication and addition rules for probability LOS : Compare and contrast dependent and independent events LOS : Calculate and interpret an unconditional probability using the total probability ruleLearning Objectives (2/2) LOS : Calculate and interpret the expected value, variance, and standard deviation of random variables LOS : Explain the use of conditional expectation in investment applications LOS : Interpret a probability tree and demonstrate its application to investment problems LOS : Calculate and interpret the expected value, variance, standard deviation, covariances, and correlations of portfolio returns LOS : Calculate and interpret the covariances of portfolio returns using the joint probability function LOS : Calculate and interpret an updated probability using Bayes’ formula LOS : Identify the most appropriate method to solve a particular counting problem and analyze counting problems using factorial, combination, and permutation concepts