Practice Problems 347

PRACTICE PROBLEMS
1 Perkiomen Kinzua, a seasoned auditor, is auditing last year’s transactions for
Conemaugh Corporation. Unfortunately, Conemaugh had a very large number
of transactions last year, and Kinzua is under a time constraint to nish the
audit. He decides to audit only the small subset of the transaction population
that is of interest and to use sampling to create that subset.
e most appropriate sampling method for Kinzua to use is:
A judgmental sampling.
B systematic sampling.
C convenience sampling.
2 Which one of the following statements is true about non-probability sampling?
A ere is signi cant risk that the sample is not representative of the
population.
B Every member of the population has an equal chance of being selected for
the sample.
C Using judgment guarantees that population subdivisions of interest are rep-
resented in the sample.
3 e best approach for creating a strati ed random sample of a population
involves:
A drawing an equal number of simple random samples from each
subpopulation.
B selecting every kth member of the population until the desired sample size
is reached.
C drawing simple random samples from each subpopulation in sizes propor-
tional to the relative size of each subpopulation.
4 Although he knows security returns are not independent, a colleague makes
the claim that because of the central limit theorem, if we diversify across a
large number of investments, the portfolio standard deviation will eventually
approach zero as n becomes large. Is he correct?
5 Why is the central limit theorem important?
6 What is wrong with the following statement of the central limit theorem?
Central Limit eorem. “If the random variables X1, X2, X3, …, Xn are a
random sample of size n from any distribution with nite mean μ and
variance σ2, then the distribution of X will be approximately normal, with a
standard deviation of n .”
7 Peter Biggs wants to know how growth managers performed last year. Biggs
assumes that the population cross-sectional standard deviation of growth man-
ager returns is 6% and that the returns are independent across managers.
A How large a random sample does Biggs need if he wants the standard devia-
tion of the sample means to be 1%?
B How large a random sample does Biggs need if he wants the standard devia-
tion of the sample means to be 0.25%?

© 2021 CFA Institute. All rights reserved.

348 Reading 5 ■ Sampling and Estimation

8 Petra Munzi wants to know how value managers performed last year. Munzi
estimates that the population cross-sectional standard deviation of value
manager returns is 4% and assumes that the returns are independent across
managers.
A Munzi wants to build a 95% con dence interval for the population mean
return. How large a random sample does Munzi need if she wants the 95%
con dence interval to have a total width of 1%?
B Munzi expects a cost of about $10 to collect each observation. If she has
a $1,000 budget, will she be able to construct the con dence interval she
wants?
9 Find the reliability factors based on the t-distribution for the following con -
dence intervals for the population mean (df = degrees of freedom, n = sample
size):
A A 99% con dence interval, df = 20
B A 90% con dence interval, df = 20
C A 95% con dence interval, n = 25
D A 95% con dence interval, n = 16
10 Assume that monthly returns are normally distributed with a mean of 1%
and a sample standard deviation of 4%. e population standard deviation is
unknown. Construct a 95% con dence interval for the sample mean of monthly
returns if the sample size is 24.
11 Explain the di erences between constructing a con dence interval when sam-
pling from a normal population with a known population variance and sam-
pling from a normal population with an unknown variance.
12 Suppose we take a random sample of 30 companies in an industry with 200
companies. We calculate the sample mean of the ratio of cash ow to total debt
for the prior year. We nd that this ratio is 23%. Subsequently, we learn that the
population cash ow to total debt ratio (taking account of all 200 companies) is
26%. What is the explanation for the discrepancy between the sample mean of
23% and the population mean of 26%?
A Sampling error.
B Bias.
C A lack of consistency.
13 Alcorn Mutual Funds is placing large advertisements in several nancial pub-
lications. e advertisements prominently display the returns of 5 of Alcorn’s
30 funds for the past 1-, 3-, 5-, and 10-year periods. e results are indeed
impressive, with all of the funds beating the major market indexes and a few
beating them by a large margin. Is the Alcorn family of funds superior to its
competitors?
14 Julius Spence has tested several predictive models in order to identify under-
valued stocks. Spence used about 30 company- speci c variables and 10
market-related variables to predict returns for about 5,000 North American
and European stocks. He found that a nal model using eight variables applied
to telecommunications and computer stocks yields spectacular results. Spence
wants you to use the model to select investments. Should you? What steps
would you take to evaluate the model?
15 A population has a non-normal distribution with mean µ and variance σ2. e
sampling distribution of the sample mean computed from samples of large size
from that population will have:
A the same distribution as the population distribution.
Practice Problems 349

B its mean approximately equal to the population mean.

C its variance approximately equal to the population variance.
16 A sample mean is computed from a population with a variance of 2.45. e
sample size is 40. e standard error of the sample mean is closest to:
A 0.039.
B 0.247.
C 0.387.
17 An estimator with an expected value equal to the parameter that it is intended
to estimate is described as:
A e cient.
B unbiased.
C consistent.
18 If an estimator is consistent, an increase in sample size will increase the:
A accuracy of estimates.
B e ciency of the estimator.
C unbiasedness of the estimator.
19 For a two-sided con dence interval, an increase in the degree of con dence will
result in:
A a wider con dence interval.
B a narrower con dence interval.
C no change in the width of the con dence interval.
20 For a sample size of 17, with a mean of 116.23 and a variance of 245.55, the
width of a 90% con dence interval using the appropriate t-distribution is closest
to:
A 13.23.
B 13.27.
C 13.68.
21 For a sample size of 65 with a mean of 31 taken from a normally distributed
population with a variance of 529, a 99% con dence interval for the population
mean will have a lower limit closest to:
A 23.64.
B 25.41.
C 30.09.
22 An increase in sample size is most likely to result in a:
A wider con dence interval.
B decrease in the standard error of the sample mean.
C lower likelihood of sampling from more than one population.
23 Otema Chi has a spreadsheet with 108 monthly returns for shares in Marunou
Corporation. He writes a software program that uses bootstrap resampling to
create 200 resamples of this Marunou data by sampling with replacement. Each
resample has 108 data points. Chi’s program calculates the mean of each of
the 200 resamples, and then it calculates that the mean of these 200 resample
means is 0.0261. e program subtracts 0.0261 from each of the 200 resample
means, squares each of these 200 di erences, and adds the squared di erences
together. e result is 0.835. e program then calculates an estimate of the
standard error of the sample mean.
350 Reading 5 ■ Sampling and Estimation

e estimated standard error of the sample mean is closest to:

A 0.0115
B 0.0648
C 0.0883
24 Compared with bootstrap resampling, jackknife resampling:
A is done with replacement.
B usually requires that the number of repetitions is equal to the sample size.
C produces dissimilar results for every run because resamples are randomly
drawn.
25 A report on long- term stock returns focused exclusively on all currently pub-
licly traded rms in an industry is most likely susceptible to:
A look-ahead bias.
B survivorship bias.
C intergenerational data mining.
26 Which sampling bias is most likely investigated with an out-of-sample test?
A Look-ahead bias
B Data-mining bias
C Sample selection bias
27 Which of the following characteristics of an investment study most likely indi-
cates time- period bias?
A e study is based on a short time-series.
B Information not available on the test date is used.
C A structural change occurred prior to the start of the study’s time series.
412 Reading 6 ■ Hypothesis Testing

PRACTICE PROBLEMS
1 Which of the following statements about hypothesis testing is correct?
A e null hypothesis is the condition a researcher hopes to support.
B e alternative hypothesis is the proposition considered true without con-
clusive evidence to the contrary.
C e alternative hypothesis exhausts all potential parameter values not
accounted for by the null hypothesis.
2 Identify the appropriate test statistic or statistics for conducting the following
hypothesis tests. (Clearly identify the test statistic and, if applicable, the number
of degrees of freedom. For example, “We conduct the test using an x-statistic
with y degrees of freedom.”)
A H0: μ = 0 versus Ha: μ ≠ 0, where μ is the mean of a normally distributed
population with unknown variance. e test is based on a sample of 15
observations.
B H0: μ = 5 versus Ha: μ ≠ 5, where μ is the mean of a normally distributed
population with unknown variance. e test is based on a sample of 40
observations.
C H0: μ ≤ 0 versus Ha: μ > 0, where μ is the mean of a normally distributed
population with known variance σ2. e sample size is 45.
D H0: σ2 = 200 versus Ha: σ2 ≠ 200, where σ2 is the variance of a normally
distributed population. e sample size is 50.
2 2 2 2 2
E H0 : 1 2 versus H a : 1 2, where 1 is the variance of one normally
2
distributed population and is the variance of a second normally distrib-
2
uted population. e test is based on two independent samples, with the
rst sample of size 30 and the second sample of size 40.
F H0: μ1 − μ2 = 0 versus Ha: μ1 − μ2 ≠ 0, where the samples are drawn from
normally distributed populations with unknown but assumed equal vari-
ances. e observations in the two samples (of size 25 and 30, respectively)
are independent.
3 For each of the following hypothesis tests concerning the population mean, μ,
state the conclusion regarding the test of the hypotheses.
A H0: μ = 10 versus Ha: μ ≠ 10, with a calculated t-statistic of 2.05 and critical
t-values of ±1.984.
B H0: μ ≤ 10 versus Ha: μ > 10, with a calculated t-statistic of 2.35 and a criti-
cal t-value of +1.679
C H0: μ = 10 versus Ha: μ ≠ 10, with a calculated t-statistic of 2.05, a p-value of
4.6352%, and a level of signi cance of 5%.
D H0: μ ≤ 10 versus Ha: μ > 10, with a 2% level of signi cance and a calculated
test statistic with a p-value of 3%.
4 For each of the following hypothesis tests concerning the population mean,
state the conclusion.
A H0: σ2 = 0.10 versus Ha: σ2 ≠ 0.10, with a calculated chi-square test statistic
of 45.8 and critical chi-square values of 42.950 and 86.830.
B H0: σ2 = 0.10 versus Ha: σ2 ≠ 0.10, with a 5% level of signi cance and a
p-value for this calculated chi-square test statistic of 4.463%.

© 2021 CFA Institute. All rights reserved.

Practice Problems 413

C H0: σ12 = σ22 versus Ha: σ12 ≠ σ22, with a calculated F-statistic of 2.3. With
40 and 30 degrees of freedom, the critical F-values are 0.498 and 1.943.
D H0: σ2 ≤ 10 versus Ha: μσ2 > 10, with a calculated test statistic of 32 and a
critical chi-square value of 26.296.
5 Willco is a manufacturer in a mature cyclical industry. During the most recent
industry cycle, its net income averaged $30 million per year with a standard
deviation of $10 million (n = 6 observations). Management claims that Willco’s
performance during the most recent cycle results from new approaches and
that Willco’s pro tability will exceed the $24 million per year observed in prior
cycles.
A With μ as the population value of mean annual net income, formulate null
and alternative hypotheses consistent with testing Willco management’s
claim.
B Assuming that Willco’s net income is at least approximately normally dis-
tributed, identify the appropriate test statistic and calculate the degrees of
freedom.
C Based on critical value of 2.015, determine whether to reject the null
hypothesis.

The following information relates to Questions

6–7
Performance in Forecasting Quarterly Earnings per Share
Number of Mean Forecast Error Standard Deviation of
Forecasts (Predicted − Actual) Forecast Errors

Analyst A 10 0.05 0.10

Analyst B 15 0.02 0.09

Critical t-values:

Area in the Right-Side Rejection Area

Degrees of Freedom p = 0.05 p = 0.025

8 1.860 2.306
9 1.833 2.262
10 1.812 2.228
11 1.796 2.201
12 1.782 2.179
13 1.771 2.160
14 1.761 2.145
15 1.753 2.131
16 1.746 2.120
17 1.740 2.110
18 1.734 2.101
19 1.729 2.093
20 1.725 2.086
21 1.721 2.080
(continued)
414 Reading 6 ■ Hypothesis Testing

Area in the Right-Side Rejection Area

Degrees of Freedom p = 0.05 p = 0.025
22 1.717 2.074
23 1.714 2.069
24 1.711 2.064
25 1.708 2.060
26 1.706 2.056
27 1.703 2.052

6 Investment analysts often use earnings per share (EPS) forecasts. One test of
forecasting quality is the zero-mean test, which states that optimal forecasts
should have a mean forecasting error of zero. e forecasting error is the
di erence between the predicted value of a variable and the actual value of the
variable.
You have collected data (shown in the previous table) for two analysts who
cover two di erent industries: Analyst A covers the telecom industry; Analyst B
covers automotive parts and suppliers.
A With μ as the population mean forecasting error, formulate null and alterna-
tive hypotheses for a zero-mean test of forecasting quality.
B For Analyst A, determine whether to reject the null at the 0.05 level of
signi cance.
C For Analyst B, determine whether to reject the null at the 0.05 level of
signi cance.
7 Reviewing the EPS forecasting performance data for Analysts A and B, you
want to investigate whether the larger average forecast errors of Analyst A
relative to Analyst B are due to chance or to a higher underlying mean value
for Analyst A. Assume that the forecast errors of both analysts are normally dis-
tributed and that the samples are independent.
A Formulate null and alternative hypotheses consistent with determining
whether the population mean value of Analyst A’s forecast errors (μ1) are
larger than Analyst B’s (μ2).
B Identify the test statistic for conducting a test of the null hypothesis formu-
lated in Part A.
C Identify the rejection point or points for the hypotheses tested in Part A at
the 0.05 level of signi cance.
D Determine whether to reject the null hypothesis at the 0.05 level of
signi cance.

8 e following table gives data on the monthly returns on the S&P 500 Index
and small-cap stocks for a 40-year period and provides statistics relating to
their mean di erences. Further, the entire sample period is split into two subpe-
riods of 20 years each, and the return data for these subperiods is also given in
the table.
Practice Problems 415

S&P 500 Small-Cap Di erences

Return Stock Return (S&P 500 − Small-Cap
Measure (%) (%) Stock)

Entire sample period, 480 months

Mean 1.0542 1.3117 −0.258
Standard deviation 4.2185 5.9570 3.752
First subperiod, 240 months
Mean 0.6345 1.2741 −0.640
Standard deviation 4.0807 6.5829 4.096
Second subperiod, 240 months
Mean 1.4739 1.3492 0.125
Standard deviation 4.3197 5.2709 3.339

Use a signi cance level of 0.05 and assume that mean di erences are approxi-
mately normally distributed.
A Formulate null and alternative hypotheses consistent with testing whether
any di erence exists between the mean returns on the S&P 500 and small-
cap stocks.
B Determine whether to reject the null hypothesis for the entire sample period
if the critical values are ±1.96.
C Determine whether to reject the null hypothesis for the rst subperiod if the
critical values are ±1.96.
D Determine whether to reject the null hypothesis for the second subperiod if
the critical values are ±1.96.
9 During a 10-year period, the standard deviation of annual returns on a portfolio
you are analyzing was 15% a year. You want to see whether this record is su -
cient evidence to support the conclusion that the portfolio’s underlying variance
of return was less than 400, the return variance of the portfolio’s benchmark.
A Formulate null and alternative hypotheses consistent with your objective.
B Identify the test statistic for conducting a test of the hypotheses in Part A,
and calculate the degrees of freedom.
C Determine whether the null hypothesis is rejected or not rejected at the 0.05
level of signi cance using a critical value of 3.325.
10 You are investigating whether the population variance of returns on an index
changed subsequent to a market disruption. You gather the following data for
120 months of returns before the disruption and for 120 months of returns after
the disruption. You have speci ed a 0.05 level of signi cance.
Mean Monthly
Return
Time Period n (%) Variance of Returns

Before disruption 120 1.416 22.367

After disruption 120 1.436 15.795

A Formulate null and alternative hypotheses consistent with the research goal.
B Identify the test statistic for conducting a test of the hypotheses in Part A,
and calculate the degrees of freedom.
C Determine whether to reject the null hypothesis at the 0.05 level of signi -
cance if the critical values are 0.6969 and 1.4349.
416 Reading 6 ■ Hypothesis Testing

11 e following table shows the sample correlations between the monthly returns
for four di erent mutual funds and the S&P 500. e correlations are based on
36 monthly observations. e funds are as follows:
Fund 1 Large-cap fund
Fund 2 Mid-cap fund
Fund 3 Large-cap value fund
Fund 4 Emerging market fund
S&P 500 US domestic stock index

Fund 1 Fund 2 Fund 3 Fund 4 S&P 500

Fund 1 1
Fund 2 0.9231 1
Fund 3 0.4771 0.4156 1
Fund 4 0.7111 0.7238 0.3102 1
S&P 500 0.8277 0.8223 0.5791 0.7515 1

Test the null hypothesis that each of these correlations, individually, is equal
to zero against the alternative hypothesis that it is not equal to zero. Use a 5%
signi cance level and critical t-values of ±2.032.
12 In the step “stating a decision rule” in testing a hypothesis, which of the follow-
ing elements must be speci ed?
A Critical value
B Power of a test
C Value of a test statistic
13 Which of the following statements is correct with respect to the null
hypothesis?
A It can be stated as “not equal to” provided the alternative hypothesis is
stated as “equal to.”
B Along with the alternative hypothesis, it considers all possible values of the
population parameter.
C In a two-tailed test, it is rejected when evidence supports equality between
the hypothesized value and the population parameter.
14 An analyst is examining a large sample with an unknown population variance.
Which of the following is the most appropriate test to test the hypothesis that
the historical average return on an index is less than or equal to 6%?
A One-sided t-test
B Two-sided t-test
C One-sided chi-square test
15 A hypothesis test for a normally distributed population at a 0.05 signi cance
level implies a:
A 95% probability of rejecting a true null hypothesis.
B 95% probability of a Type I error for a two-tailed test.
C 5% critical value rejection region in a tail of the distribution for a one-tailed
test.
16 Which of the following statements regarding a one-tailed hypothesis test is
correct?
Practice Problems 417

A e rejection region increases in size as the level of signi cance becomes

smaller.
B A one-tailed test more strongly re ects the beliefs of the researcher than a
two-tailed test.
C e absolute value of the rejection point is larger than that of a two-tailed
test at the same level of signi cance.
17 e value of a test statistic is best described as the basis for deciding whether to:
A reject the null hypothesis.
B accept the null hypothesis.
C reject the alternative hypothesis.
18 Which of the following is a Type I error?
A Rejecting a true null hypothesis
B Rejecting a false null hypothesis
C Failing to reject a false null hypothesis
19 A Type II error is best described as:
A rejecting a true null hypothesis.
B failing to reject a false null hypothesis.
C failing to reject a false alternative hypothesis.
20 e level of signi cance of a hypothesis test is best used to:
A calculate the test statistic.
B de ne the test’s rejection points.
C specify the probability of a Type II error.
21 You are interested in whether excess risk-adjusted return (alpha) is correlated
with mutual fund expense ratios for US large-cap growth funds. e following
table presents the sample.
Mutual Fund Alpha Expense Ratio

1 −0.52 1.34
2 −0.13 0.40
3 −0.50 1.90
4 −1.01 1.50
5 −0.26 1.35
6 −0.89 0.50
7 −0.42 1.00
8 −0.23 1.50
9 −0.60 1.45

A Formulate null and alternative hypotheses consistent with the verbal

description of the research goal.
B Identify and justify the test statistic for conducting a test of the hypotheses
in Part A.
C Determine whether to reject the null hypothesis at the 0.05 level of signi -
cance if the critical values are ±2.306.
22 All else equal, is specifying a smaller signi cance level in a hypothesis test likely
to increase the probability of a:
418 Reading 6 ■ Hypothesis Testing

Type I error? Type II error?

A. No No
B. No Yes
C. Yes No

23 e probability of correctly rejecting the null hypothesis is the:

A p-value.
B power of a test.
C level of signi cance.
24 e power of a hypothesis test is:
A equivalent to the level of signi cance.
B the probability of not making a Type II error.
C unchanged by increasing a small sample size.
25 When making a decision about investments involving a statistically signi cant
result, the:
A economic result should be presumed to be meaningful.
B statistical result should take priority over economic considerations.
C economic logic for the future relevance of the result should be further
explored.
26 An analyst tests the pro tability of a trading strategy with the null hypothesis
that the average abnormal return before trading costs equals zero. e calcu-
lated t-statistic is 2.802, with critical values of ±2.756 at signi cance level α
= 0.01. After considering trading costs, the strategy’s return is near zero. e
results are most likely:
A statistically but not economically signi cant.
B economically but not statistically signi cant.
C neither statistically nor economically signi cant.
27 Which of the following statements is correct with respect to the p-value?
A It is a less precise measure of test evidence than rejection points.
B It is the largest level of signi cance at which the null hypothesis is rejected.
C It can be compared directly with the level of signi cance in reaching test
conclusions.
28 Which of the following represents a correct statement about the p-value?
A e p-value o ers less precise information than does the rejection points
approach.
B A larger p-value provides stronger evidence in support of the alternative
hypothesis.
C A p-value less than the speci ed level of signi cance leads to rejection of the
null hypothesis.
29 Which of the following statements on p-value is correct?
A e p-value indicates the probability of making a Type II error.
B e lower the p-value, the weaker the evidence for rejecting the H0.
C e p-value is the smallest level of signi cance at which H0 can be rejected.
30 e following table shows the signi cance level (α) and the p-value for two
hypothesis tests.
Practice Problems 419

α p-Value

Test 1 0.02 0.05

Test 2 0.05 0.02

In which test should we reject the null hypothesis?

A Test 1 only
B Test 2 only
C Both Test 1 and Test 2
31 Which of the following tests of a hypothesis concerning the population mean is
most appropriate?
A A z-test if the population variance is unknown and the sample is small
B A z-test if the population is normally distributed with a known variance
C A t-test if the population is non-normally distributed with unknown vari-
ance and a small sample
32 For a small sample from a normally distributed population with unknown vari-
ance, the most appropriate test statistic for the mean is the:
A z-statistic.
B t-statistic.
C χ2 statistic.
33 An investment consultant conducts two independent random samples of
ve-year performance data for US and European absolute return hedge funds.
Noting a return advantage of 50 bps for US managers, the consultant decides
to test whether the two means are di erent from one another at a 0.05 level of
signi cance. e two populations are assumed to be normally distributed with
unknown but equal variances. Results of the hypothesis test are contained in
the following tables.
Mean Return Standard
Sample Size (%) Deviation

US managers 50 4.7 5.4

European managers 50 4.2 4.8

Null and alternative hypotheses H0: μUS − μE = 0; Ha: μUS − μE ≠ 0

Calculated test statistic 0.4893
Critical value rejection points ±1.984

e mean return for US funds is μUS, and μE is the mean return for European funds.

e results of the hypothesis test indicate that the:

A null hypothesis is not rejected.
B alternative hypothesis is statistically con rmed.
C di erence in mean returns is statistically di erent from zero.
34 A pooled estimator is used when testing a hypothesis concerning the:
A equality of the variances of two normally distributed populations.
B di erence between the means of two at least approximately normally dis-
tributed populations with unknown but assumed equal variances.
420 Reading 6 ■ Hypothesis Testing

C di erence between the means of two at least approximately normally dis-

tributed populations with unknown and assumed unequal variances.
35 When evaluating mean di erences between two dependent samples, the most
appropriate test is a:
A z-test.
B chi-square test.
C paired comparisons test.
36 A chi- square test is most appropriate for tests concerning:
A a single variance.
B di erences between two population means with variances assumed to be
equal.
C di erences between two population means with variances assumed to not
be equal.
37 Which of the following should be used to test the di erence between the vari-
ances of two normally distributed populations?
A t-test
B F-test
C Paired comparisons test
38 Jill Batten is analyzing how the returns on the stock of Stellar Energy Corp. are
related with the previous month’s percentage change in the US Consumer Price
Index for Energy (CPIENG). Based on 248 observations, she has computed the
sample correlation between the Stellar and CPIENG variables to be −0.1452.
She also wants to determine whether the sample correlation is signi cantly
di erent from zero. e critical value for the test statistic at the 0.05 level of
signi cance is approximately 1.96. Batten should conclude that the statistical
relationship between Stellar and CPIENG is:
A signi cant, because the calculated test statistic is outside the bounds of the
critical values for the test statistic.
B signi cant, because the calculated test statistic has a lower absolute value
than the critical value for the test statistic.
C insigni cant, because the calculated test statistic is outside the bounds of
the critical values for the test statistic.
39 In which of the following situations would a nonparametric test of a hypothesis
most likely be used?
A e sample data are ranked according to magnitude.
B e sample data come from a normally distributed population.
C e test validity depends on many assumptions about the nature of the
population.
40 An analyst is examining the monthly returns for two funds over one year. Both
funds’ returns are non-normally distributed. To test whether the mean return of
one fund is greater than the mean return of the other fund, the analyst can use:
A a parametric test only.
B a nonparametric test only.
C both parametric and nonparametric tests.
41 An analyst group follows 250 rms and classi es them in two dimensions. First,
they use dividend payment history and earnings forecasts to classify rms into
one of three groups, with 1 indicating the dividend stars and 3 the dividend lag-
gards. Second, they classify rms on the basis of nancial leverage, using debt
Practice Problems 421

ratios, debt features, and corporate governance to classify the rms into three
groups, with 1 indicating the least risky rms based on nancial leverage and 3
indicating the riskiest. e classi cation of the 250 rms is as follows:

Financial Leverage Dividend Group

Group 1 2 3

1 40 40 40
2 30 10 20
3 10 50 10

A What are the null and alternative hypotheses to test whether the dividend
and nancial leverage groups are independent of one another?
B What is the appropriate test statistic to use in this type of test?
C If the critical value for the 0.05 level of signi cance is 9.4877, what is your
conclusion?
42 Which of the following statements is correct regarding the chi-square test of
independence?
A e test has a one-sided rejection region.
B e null hypothesis is that the two groups are dependent.
C If there are two categories, each with three levels or groups, there are six
degrees of freedom.