CFA

Reading 8

HYPOTHESIS TESTING

1. (A) Nonparametric tests rely on population parameters.

Explanation
Nonparametric tests are not concerned with parameters; they make minimal
assumptions about the population from which a sample comes. It is important to
distinguish between the test of the difference in the means and the test of the
mean of the differences. Also, it is important to understand that parametric tests
rely on distributional assumptions, whereas nonparametric tests are not as strict
regarding distributional properties.
(Module 8.2, LOS 8.c)

2. (B) 19.99.
Explanation
With a large sample size (75) the z-statistic is used. The z-statistic is calculated
by subtracting the hypothesized parameter from the parameter that has been
timated and dividing the difference by the standard error of the sample statistic.
Here, the test statistic
= (sample mean – hypothesized mean) / (sample standard deviation /
(sample size)1/2
= (X− μ) / (σ / n1/2) = (57,000 – 54,000) / (1,300 / 751/2) = (3,000) / (1,300 / 8.66)
= 19.99.
(Module 8.2, LOS 8.b)

3. (B) nonparametric test

Explanation
A rank correlation test is best described as a nonparametric test.
(Module 8.2, LOS 8.c)

4. (A) made a Type II error.

Explanation
This statement is an example of a Type II error, which occurs when you fail to
reject a hypothesis when it is actually false.
The other statements are incorrect. A Type I error is the rejection of a
hypothesis when it is actually true.
(Module 8.2, LOS 8.b)

Quantative Method 1 Hypothesis Testing

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5. (B) The value of a population variance.
Explanation
A chi-square test is a hypothesis test used to assess the value of a population
variance. The value of a population mean will use either a t-test (for a small
sample) or a z-test (for a large sample). An F-test can be used to assess the
equality of two population variances.
(Module 8.2, LOS 8.b)

6. (A) A Type I error is the probability of rejecting the null hypothesis when the
null hypothesis is false.
Explanation
A Type I error is the probability of rejecting the null hypothesis when the null
hypothesis is true.
(Module 8.1, LOS 8.a)

7. (B) 10.56.
Explanation
With a large sample size (135) the z-statistic is used. The z-statistic is
calculated by subtracting the hypothesized parameter from the parameter that
has been estimated and dividing the difference by the standard error of the
sample statistic. Here, the test statistic
= (sample mean – hypothesized mean) / (population standard deviation /
(sample size)1/2)
= (X − μ) / (σ / n1/2) = (64,000 – 59,000) / (5,500 / 1351/2)
= (5,000) / (5,500 / 11.62) = 10.56.
(Module 8.2, LOS 8.b)

8. (B) 19.06.
Explanation
With a large sample size (115) the z-statistic is used. The z-statistic is
calculated by subtracting the hypothesized parameter from the parameter that
has been estimated and dividing the difference by the standard error of the
sample statistic. Here, the test statistic
= (sample mean – hypothesized mean) / (population standard deviation /
(sample size)1/2
= (X − μ) / (σ / n1/2) = (65,000 – 57,000) / (4,500 / 1151/2)
= (8,000) / (4,500 / 10.72) = 19.06.
(Module 8.2, LOS 8.b)

Quantative Method 2 Hypothesis Testing

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9. (C) the confidence level of the test is 95%.
Explanation
Rejecting the null hypothesis when it is true is a Type I error. The probability of
a Type Ierror is the significance level of the test and one minus the significance
level is the confidence level. The power of a test is one minus the probability of
a Type II error, which cannot be calculated from the information given.
(Module 8.1, LOS 8.a)

10. (B) significance level of the test is 5%.

Explanation
Rejecting the null hypothesis when it is true is a Type I error. The probability of
a Type I error is the significance level of the test. The power of a test is one
minus the probability of a Type II error, which cannot be calculated from the
information given.
(Module 8.1, LOS 8.a)

11. (B) keeping the significance level the same and increasing the sample size.
Explanation
A Type I error, which is equivalent to the level of significance, is the probability
of incorrectly rejecting a true null hypothesis. A Type II error is the probability of
incorrectly not rejecting a false null hypothesis. The "power of the test" is equal
to 1 minus the probability of a Type II error and represents the probability of
correctly rejecting a false null hypothesis.
To increase the power of the test, James could keep the significance level the
same and increase the sample size. Lowering the level of significance will
reduce the probability of a Type I error, increase the probability of a Type II
error, and decrease the power of the test. Increasing the probability of a Type II
error will decrease the power of the test.
(Module 8.2, LOS 8.b)

12. (C) a Type II error increases.

Explanation
If P(Type I error) decreases, then P(Type II error) increases. A null hypothesis
is never accepted. We can only fail to reject the null.
(Module 8.1, LOS 8.a)

13. (C) A hypothesized mean of 3, a sample mean of 6, and a standard error of the
sampling means of 2 give a sample Z-statistic of 1.5.
Explanation
Z = (6 - 3)/2 = 1.5. A Type II error is failing to reject the null hypothesis when it
is false. The null hypothesis that the population mean is less than or equal to 5
should be rejected when the sample Z-statistic is greater than the critical Z-
statistic.
(Module 8.1, LOS 8.a)

Quantative Method 3 Hypothesis Testing

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14. (C) the probability of rejecting a false null hypothesis.
Explanation
This is the definition of the power of the test: the probability of correctly rejecting
the null hypothesis (rejecting the null hypothesis when it is false).
(Module 8.1, LOS 8.a)

15. (B) true null hypothesis 5% of the time.

Explanation
The level of significance is the probability of rejecting the null hypothesis when it
is true. The probability of rejecting the null when it is false is the power of a test.
(Module 8.1, LOS8.a)

16. (A) rejects the null hypothesis when it is actually true.

Explanation
A Type I error is defined as rejecting the null hypothesis when it is actually true.
It can be thought of as a false positive.
A Type II error occurs when a researching fails to reject the null hypothesis
when it is false. It can be thought of as a false negative.
(Module 8.1, LOS 8.a)

17. (B) simple random sampling.

Explanation
In simple random sampling, each item in the population has an equal chance of
being selected. The analyst's method meets this criterion.
(Module 8.1, LOS 8.a)

18. (B) rejects a true null hypothesis.

Explanation
A Type I Error is defined as rejecting the null hypothesis when it is actually true.
The probability of committing a Type I error is the significance level or alpha
risk.
(Module 8.1, LOS 8.a)

19. (C) An increase in the sample size to 140.

Explanation
Even though numbers are provided, no calculations are needed. An increase in
the sample size will produce a lower standard error, and a lower standard error
will equate to a higher test statistic. Note that all numbers provided are positive,
such that the critical value will be a positive number. The higher the test statistic
is relative to the critical value, the more likely it is that the null hypothesis is
rejected.

Quantative Method 4 Hypothesis Testing

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A decrease in the mean return will lower the test statistic, while an increase in
the standard deviation will increase the standard error (which will decrease the
test statistic).
(Module 8.2, LOS 8.b)

20. (C) 21.62.

Explanation
With a large sample size (175) the z-statistic is used. The z-statistic is
calculated by subtracting the hypothesized parameter from the parameter that
has been estimated and dividing the difference by the standard error of the
sample statistic. Here, the test statistic
= (sample mean – hypothesized mean) / (population standard deviation /
(sample size)1/2
= (X − μ) / (σ / n 1/2) = (67,000 – 58,500) / (5,200 / 1751/2)
= (8,500) / (5,200 / 13.22) = 21.62.
(Module 8.2, LOS 8.b)

21. (B) A type I error is acceptance of a hypothesis that is actually false.

Explanation
A type I error is the rejection of a hypothesis that is actually true.
(Module 8.1, LOS 8.a)

22. (B) The alternative hypothesis would be Ha: mean > 7.

Explanation
The way the question is worded, this is a two tailed test. The alternative
hypothesis is not Ha: M > 7 because in a two-tailed test the alternative is =,
while < and > indicate one-tailed tests. A test statistic is calculated by
subtracting the hypothesized parameter from the parameter that has been
estimated and dividing the difference by the standard error of the sample
statistic. Here, the test statistic = (sample mean – hypothesized mean)
/(standard error of the sample statistic) = (5 - 7) / (1) = -2. The calculated Z is -2,
while the critical value is -1.96. The calculated test statistic of -2 falls to the left
of the critical Z-statistic of -1.96, and is in the rejection region. Thus, the null
hypothesis is rejected and the conclusion is that the sample mean of 5 is
significantly different than 7. What the negative sign shows is that the mean is
less than 7; a positive sign would indicate that the mean is more than 7. The
way the null hypothesis is written, it makes no difference whether the mean is
more or less than 7, just that it is not 7.
(Module 8.2, LOS 8.b)

Quantative Method 5 Hypothesis Testing

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23. (A) reject the null because the test statistic is greater than the critical value.
Explanation
At a 10% level of significance, the critical z-values for a two-tailed test are + or
–1.645, so the decision rule is to reject the null if the test statistic < –1.645 or >
+1.645.
With a sample size of 252 and a standard deviation of 0.12%, the standard error
is equal to:
S 0.12%
Sx = = = 0.0075593%
n 252
The test statistic is equal to:
0.0007
= = 9.26
0.000075593
Because the test statistic of 9.26 > 1.645, Rigley will reject the null that the daily
equityreturn is equal to zero.
(Module 8.2, LOS 8.b)

24. (A) rejecting a true null hypothesis.

Explanation
The Type I error is the error of rejecting the null hypothesis when, in fact, the
null is true.
(Module 8.1, LOS 8.a)

25. (C) 0.82.

Explanation
The power of the test is 1 – the probability of failing to reject a false null
(Type II error); 1 –0.18 = 0.82.
(Module 8.2, LOS 8.b)

26. (A) If the alternative hypothesis is Ha : μ > μ0, a two-tailed test is appropriate.
Explanation
The hypotheses are always stated in terms of a population parameter. Type I
and Type II are the two types of errors you can make – reject a null hypothesis
that is true or fail to reject a null hypothesis that is false. The alternative may be
one-sided (in which case a > or< sign is used) or two-sided (in which case a ≠ is
used).
(Module 8.1, LOS 8.a)

27. (A) The probability of a Type I error is equal to the significance level of the test.
Explanation
The probability of getting a test statistic outside the critical value(s) when the
null is true is the level of significance and is the probability of a Type I error. The

Quantative Method 6 Hypothesis Testing

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power of a test is 1minus the probability of a Type II error. Hypothesis testing
does not prove a hypothesis, we either reject the null or fail to reject it.
(Module 8.1, LOS 8.a)

28. (C) a Type I error only.

Explanation
Rejection of a null hypothesis when it is actually true is a Type I error.
Here, H0: μ ≤ 18inches and Ha: μ > 18 inches. Type II error is failing to reject a
null hypothesis when it is actually false.
Because a Type I error can only occur if the null hypothesis is true, and a Type II
error can only occur if the null hypothesis is false, it is logically impossible for a
test to result in both types of error at the same time.
(Module 8.2, LOS 8.b)

29. (B) fails to reject a false null hypothesis.

Explanation
A Type II error is defined as accepting the null hypothesis when it is actually
false. The chance of making a Type II error is called beta risk.
(Module 8.1, LOS 8.a)

30. (C) reject the null hypothesis that the P/E ratio variances between the two
companies are not significantly different.
Explanation
The F-test is used to assess the equality of two population variances. Here, the
comparison is between two companies' P/E ratios over a period of 20 years.
The null hypothesis for the two-tailed test is that the variances are not
significantly different, while the alternative hypothesis is that they are
significantly different.
Because the calculated F-statistic is higher than the critical F-statistic value, the
null hypothesis will be rejected.
(Module 8.2, LOS 8.b)

31. (C) The significance level of the test represents the probability of making a
Type I error.
Explanation
A Type I error is the rejection of the null when the null is actually true. The
significance level of the test (alpha) (which is one minus the confidence level) is
the probability of making a Type I error. A Type II error is the failure to reject the
null when it is actually false.
(Module 8.1, LOS 8.a)

Quantative Method 7 Hypothesis Testing

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32. (A) failing to reject a false null hypothesis.
Explanation
The Type II error is the error of failing to reject a null hypothesis that is not true.
(Module 8.1, LOS 8.a)

33. (B) has a significance level of 95%.

Explanation
This test has a significance level of 5%.
The relationship between confidence and significance is: significance level
= 1 – confidence level. We know that the significance level is 5% because the
sample size is large and the critical value of the test statistic is 1.96
(2.5% of probability is in both the upper and lower tails).
(Module 8.2, LOS 8.b)

34. (A) the null hypothesis cannot be rejected.

Explanation
For a two-tailed test at a 5% level of significance the calculated z-statistic would
have to be greater than the critical z value of 1.96 for the null hypothesis to be
rejected.
(Module 8.2, LOS 8.b)

Quantative Method 8 Hypothesis Testing