ISOM 2500 SP20 Practice 2_Solutions

1. A professor gives a quiz with 20 multiple choice questions. After grading the papers, the
professor writes down for each student the number of questions the student got right
and the number wrong. The average number of right answers is 8.13 with SD of 1.1.
What are the average and standard deviation (SD) of the number of wrong answers?
Solution:
If the mean and SD of variable X are 𝑥̄ and 𝑠 respectively, then the mean and SD of
variable a+ bX are 𝑎 + 𝑏𝑥̄ and |𝑏|𝑠 respectively, where a and b are constants.
Let 𝑋 be the variable of the number of right questions. Then 20-X is the variable of the
number of wrong questions.
Therefore, we have mean = 20 – 8.13 = 11.87 and SD =| − 1| × 1.1 = 1.1.

2.

X 0 1 2 3
P(X) 0.4 0.3 0.2 0.1
What is the mean and variance of 𝑌, where 𝑌 = 2𝑋 + 1?

Solution: Mean Y=3, Var Y=4

Mean of 𝑋= 𝐸 (𝑋) = 0 ∗ 0.4 + 1 + 0.3 + 2 ∗ 0.2 + 3 ∗ 0.1 = 1
Variance of 𝑋 = 𝑉𝑎𝑟(𝑋) = (0 − 1)9 ∗ 0.4 + (1 − 1)9 ∗ 0.3 + (2 − 1)9 ∗ 0.2 +
(3 − 1)9 ∗ 0.1 = 1
Mean of 𝑌 = 𝐸 (2𝑋 + 1) = 2𝐸 (𝑋) + 1 = 2 ∗ 1 + 1 = 3
Variance of 𝑌 = 𝑉𝑎𝑟(2𝑋 + 1) = 29 ∗ 𝑉𝑎𝑟(𝑋) = 4 ∗ 1 = 4

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3. Let X and Y be discrete random variables with their probability distributions
summarized below.

Find the variance of X−2Y, Var(X−2Y), when

1) X and Y are independent.
2) Cov(X,Y)=0.4
Solution: (1) 5.4 (2) 3.8

(1) We have : Var(X)=1.36; Var(Y)=1.01

Since X and Y are independent,
Var(X−2Y)=Var(X)+4Var(Y)+2*(-2)*Cov(X,Y)=1.36+(4×1.01)-0=5.4

(2) Sol: 3.8

Now Cov(X,Y)=0.4. Using the formula,

Var(X−2Y)= Var(X)+4Var(Y)+2*(-2)*Cov(X,Y)=1.36+(4×1.01)+(-4)*0.4=3.8

4. Here are summaries of returns of two single stock portfolios (risk free rate= 0.015)
mean variance standard
deviation
IBM 0.10 2.00 1.41
Apple 0.20 2.24 1.50
1) What are the Sharpe ratios of these two portfolios?
2) Given that the covariance of the return of IBM and Apple is 0.05, what is the
expected return and standard deviation of a portfolio where you invest half (i.e.
50%) in stock IBM and half in stock Apple?
Solution:
1) Sharpe ratio of IBM =0.060 ; Sharpe ratio of Apple =0.123.
Sharpe ratio of IBM = (0.10 – 0.015)/1.41 = 0.060
Sharpe ratio of Apple = (0.20 – 0.015)/1.5 = 0.123

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 Solution:
2) Expected return= 0.15 ; Standard deviation = 1.042

E(0.5X+0.5Y) = 0.5E(X)+0.5E(Y)= 0.5*0.1+0.5*0.2=0.15

Var(0.5X+0.5Y)=0.25Var(X)+0.25Var(Y)+2*0.5*0.5*Cov(X,Y)
= 0.25*2+0.25*2.24+0.5*0.05=1.085

Standard deviation = √1.085 = 1.042

5. A test consists of 30 multiple-choice questions. Each question has 5 choices and only one
of them is the correct answer. Suppose a student takes this exam totally unprepared, and
thus randomly choosing the answer for each question. What are the expected value and
the standard deviation of the number of questions correctly answered by this student?

Sol: Mean=6 and Stdev=2.191

A A H
µ = np , 30 × = 6 , 𝜎 9 = 𝑛𝑝𝑞 , 30 × × = 4.8
B B B
Stdev= √4.8 = 2.191

6. If the cash flow X ～ Uniform [10, 50], can you write out the probability density
function? What will be the 𝑃(5 < 𝑋 ≤ 20)?

Sol:
Probability density function
f(x) = 0, if x<10.
f(x) = 1/40, if 10<=x<=50
f(x) = 0, if x>50

Thus, p(5<X<=20)= (20-10)/40=0.25

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7. A new gas-electric hybrid car has recently hit the market. The distance traveled on 1
gallon of fuel is normally distributed with a mean of 65 miles and a standard deviation of
4 miles. Find the probability of the following events.
(a) The car travels more than 70 miles per gallon.
(b) The car travels less than 60 miles per gallon.
(c) The car travels between 55 and 70 miles per gallon.
Solution:
NOP STOUB
1) P(X > 70) = 𝑃 M Q
> H
V = P(Z > 1.25) = 1 – P(Z < 1.25) = 1 – .894 =0.105
NOP UTOUB
2) P(X < 60) = 𝑃 M Q
< H
V = P(Z < –1.25) = 0.105
BBOUB NOP STOUB
3) P(55 < X < 70) = 𝑃 M H
< Q
< H
V= P(–2.50 < Z < 1.25) = P(Z < 1.25) − P(Z <

−2.50) = 0.894− 0.006 =0.888

8. In economic downturns, companies attempt to downsize their workforces by offering

early retirement incentives to older employees. A survey of 723 companies found that
195 engage in such downsizing practices. The 99% confidence interval for the
proportion of companies that downsize their workforces by offering early retirement
incentives is ______.
Solution: [0.227, 0.312]

99% confidence level⇒ 𝛼 = 0.01, We are looking for z such that P(Z > z) = 0.005,
we use the upper percentile notation.
A^B
Critical value = 𝑧Z/9 = 𝑧T.TTB = 2.576, 𝑝̂ = S9_ = 0.270
aT.9ST(AOT.9ST)
Margin of error (L) = 2.576𝜎Ǹ = 2.576 × = 0.043
√S9_
The 99% confidence interval is [0.270 − 𝐿, 0.270 + 𝐿] = [0.227,0.312]. (z-interval)

9. The number of patients entering a regional hospital in an hour follows a distribution

with a variance of 10.8. Another random sample of 80 hours is selected. Find the width
of the 90% confidence interval for the mean of the number of patients entering the
regional hospital in an hour. (Using z-interval to estimate) (Round to 3 decimal places)

Sol: 1.208

90% confidence level

Critical value = We are looking for z such that P(Z > z) = 0.05,
we use the upper percentile notation.

Margin of error (L) =

The width of the 90% confidence interval (z-interval) = 2L = 1.208

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10. The head librarian at the Library of Congress has asked her assistant for an interval
estimate of the mean number of books checked out each day. The assistant provides
the following interval estimate: from 740 to 920 books per day.
(1) If the head librarian knows that the population standard deviation is 150 books
checked out per day, and she asked her assistant for a 95% confidence interval,
approximately how large a sample did her assistant use to determine the interval
estimate?
(2) Suppose we assume now that the population is normally distributed with a mean of
830 and standard deviation is 150. The head librarian takes a sample of 25 days.
What is the probability that its sample mean is between 800 and 890 books?

Sol:
(1) Sample=11

95% confidence level⇒ 𝛼 = 0.05

Critical value = 𝑧Z/9 = 𝑧T.T9B = 1.96
^9TOSHT
Margin of error (L) = 9
= 90
fg/h h Q h (A.^U)h (ABT)h
The sample size should be at least ih
= (^T)h
= 10.671
(A.^U)(ABT)
(∵ 𝐿 ≥ 1.96𝜎Ǹ = )
√l

(2) The probability is 0.818

The mean is 830

m^TOm_T mTTOm_T
We check Q/√l
and Q/√l
: these are the critical values

890 − 830 890 − 830 800 − 830

= = 2, = −1
𝜎/√𝑛 150/√25 150/√25

P(Z<2)=0.9772
P(Z<-1)=0.1587 (Check the normal table)
The probability of lying in between 800 and 890 is 0.9772-0.1587=0.818