FRM Part - I│ Test ID - 0015│Ques ons – 60

How to fill Test ID & Roll No

(Note – Please encircle Roll NO and TEST ID

properly)

Test Topics –
Probability,Distribution,Statistics,Bayesian
Model.

Probabilities

1. Which of the following can be categorized as continuous random variables?

I. Stock indices
II. The weight of 20 FRM candidates
III. Biannual share dividends received over a 10-year
period IV. The income of citizens in a given district
V. The annual number of FRM exam candidates in the last 10 years
A. I, III, and V
B. I, II, and III
C. II and V
D. All the above

The correct answer is: B).

A continuous random variable is a variable that has infinite possible outcomes, even though lower and
upper bounds exist. It differs from a discrete random variable which takes on only a countable number
of values. As an example, between 2433 and 2434, the S&P 500 index can take on
2433.00, 3433.23, 2433.89, 2433.07, etc. On the other hand, the number of FRM candidates in any
given year can only take on an integer/whole number value.

2. Consider the following probability function for a discrete random variable

X: X = {10, 20, 30, Y,}, P(x) = x/100, otherwise P(x) = 0

Find the value of Y.

A. 4
B. 40
C. 50
D. 5
The correct answer is: B).

There are two key properties that any probability function must meet. These are:
I. 0 ≤ P(x) ≤ 1
II. ∑P(x) = 1

Therefore,
10/100 + 20/100 + 30/100 + Y/100 = 1
60/100 + Y/100 = 1
60 + Y = 100
Y = 40

3. A zero-coupon bond with a notional value of $100 and price x has the following
probability density function:

f(x) = x/5000 for 0 ≤ x ≤ 100

Determine the probability that the price of the bond is between $80 and $90.
A. 0.0017
B. 0.81
C. 0.17
D. 0.64
The correct answer is: C).

To find the required probability, simply integrate the given probability density function between
80 and 90.

=80∫ 90x/5,000dx
= [x2/10,000]x = 90 - [x2/10,000] x = 80
= 8100/10,000 – 6400/10,000
= 0.81 – 0.64
= 0.17 or 17%

4. Given the following probability density function for a discrete random variable X,
determine F(30).

X = {10, 20, 30, 40}, P(x) = x/100

A. 0.2
B. 0.3
C. 0.7
D. 0.6
The correct answer is: D).

The cumulative distribution function (cdf) F(x) defines the probability that a random variable X, and
assumes a value equal to or less than a specified value, x. As such:

F(30) = P(X = 30)

= P(X = 10) + P(X = 20) + P(X = 30)
= 10/100 + 20/100 + 30/100
= 0.6 or 60%

5. The probability of an increase in the annual dividend paid out to shareholders of ABC
Limited is 0.4. The probability of an increase in share price given an increase in dividends is
0.7. Determine the joint probability of an increase in dividends and an increase in share price.
A. 0.28
B. 0.14
C. 0.72
D. 0.3
The correct answer is: A).

Let:
A be the event that the dividend is increased and,
B be the event that the share price increases
Therefore, P(A) = 0.4 and P(B | A) = 0.7
The joint probability of an increase in dividends and an increase in share price is P(B ᴖ A)

The multiplication rule of probability states that:

P(B | A) = P(B ᴖ A)/P(A)
Hence P(B ᴖ A) = P(B | A) * P(A)
= 0.7 * 0.4
= 0.28 or 28% (Note that P(A ᴖ B) = P(B ᴖ A))
6. Two events are said to be independent and mutually exclusive
if: A. The events cannot occur at the same time

B. The occurrence of one of the events does not affect the probability of the occurrence of the
other event

C. The occurrence of one of the events does not affect the probability of the occurrence of
the other event and the events cannot occur at the same time
D. The occurrence of one of the events means the second event is certain to occur
The correct answer is: C).

Independent events are those whose occurrences are uncorrelated. The occurrence of one event
does not in any way affect the chances of the other event occurring. In addition, if two events are
mutually exclusive, it means they cannot occur at the same time. For example, if a fair coin is
tossed, it’s impossible to obtain a head and a tail at the same time since the two possible outcomes
are mutually exclusive.

7. A financial risk manager exam candidate is asked two questions. The probability that she
gets the first question correct is 0.4 and the probability that she gets the second question correct
is 0.5. Given that the probability that she gets both questions correct is 0.2, determine the
probability that she gets either the first or the second question correct.
A. 0.9
B. 0.7
C. 0.1
D. 0.4
The correct answer is: B).

Let A = {gets first question right} and B = {gets second question right}
Therefore, P(A) = 0.4, P(B) = 0.5, and P(A ᴖ B) = 0.2
We want to determine P(A ᴗ B);
The addition rule states that P(A ᴗ B) = P(A) + P(B) – P(A ᴖ B)
Hence, P(A ᴗ B) = 0.4 + 0.5 – 0.2 = 0.7

8. An empirical study of ABC stock listed on the New York Exchange reveals that the stock has
closed higher on one-third of all days in the past few months. Given that up and down days are
independent, determine the probability of ABC stock closing higher for six consecutive days.
A. 0.17
B. 0.0137
C. 0.03704
D. 0.00137
The correct answer is: D).

From the information above, we can establish that the probability of closing higher = 1/3

Using independence, the probability of 6 consecutive “highs” = 1/3 * 1/3 * 1/3 * 1/3 * 1/3 * 1/3
= 1/729

(The calculation above follows from the fact that if A and B are independent events, then P(A ᴖ B)
= P(A) * P(B).)

9. A fruit juice shop allows customers to choose apple juice, mango juice or passion juice. The
probability of a customer ordering passion juice is 0.45, mango juice and apple juice 0.19,
passion juice and mango juice 0.15, passion juice and apple juice 0.25, passion juice or
mango juice 0.6, passion juice or apple juice 0.84, and 0.9 for at least one of them.

Find the probability that a customer orders all the three juices.
A. 0.64
B. 0.1
C. 0.3
D. 0.25
The correct answer is: B).

Let:
A be the event that a customer chooses/orders apple juice
M be the event that a customer chooses mango juice
S be the event that a customer chooses passion fruit

We can easily establish that:

P(S) = 0.45, P(M ᴖ A) = 0.19, P(M ᴖ S) = 0.15, P(A ᴖ S) = 0.25, P(M ᴗ S) = 0.6, P(A ᴗ S) = 0.84,
P(A ᴗ M ᴗ S) = 0.9

We need to determine P(A ᴖ M ᴖ S):

Borrowing from the addition rule with three sets,
P(A ᴗ M ᴗ S) = P(A) + P(M) + P(S) - P(M ᴖ A) - P(M ᴖ S) - P(A ᴖ S) + P(A ᴖ M ᴖ
S)…………………..equation (I)

P(M ᴗ S) = P(M) + P(S) – P(M ᴖ S),

P(M) = 0.6 + 0.15 – 0.45 = 0.3

Similarly, P(A ᴗ S) = P(A) + P(S) - P(A ᴖ S)

P(A) = 0.84 – 0.45 + 0.25 = 0.64

Therefore applying equation (I),

0.9 = 0.64 + 0.3 + 0.45 – 0.19 – 0.15 – 0.25 + P(A ᴖ M ᴖ S)

Which gives us P(A ᴖ M ᴖ S) = 0.1

10. A random variable X with an exponential distribution has the following probability
density function:

FX(x) = λe- xy

You are required to determine the probability density function of the random variable X,
given that Y = X2
A. 1 – e-λy^1/2
B.– e-λy^1/2
C. 1/2 λy- ½ e- λy^1/2
D. 1
The correct answer is: C).

From first principles, it can be shown that:

FY(y) = P(Y ≤ y) = P(X2 ≤ y) = P(X ≤ y1/2)

Applying integration:
P(X ≤ y1/2) = 0∫y^1/2(λe-xy)dx = [-e-λx]x = y^1/2 - [-e- λx]x = 0 = 1 – e-
- ½ -λy^1/2
λy^1/2 FY(y) = F’Y(y) = 1/2 λy e

11. During a lottery, 400 names are fed into a computer program. Five of the names are
identical. If a name is drawn from the program at random, what is the probability that one
of these 5 names will be drawn?
A.0.0125
B. 0.25
C. 0.0025
D. 0.0625
The correct answer is: A).

P(name 1 ᴗ name 2 ᴗ name 3 ᴗ name 4 ᴗ name 5) = 1/400 + 1/400 + 1/400 + 1/400 + 1/400
= 0.0125

12. If two events are not independent, the joint probability of A and B, P(A ᴖ B) is equal
to: A. P(A | B)/P(B)
B. P(A | B) * P(B)

C. P(A) * P(B)
D. None of the above
The correct answer is: B).

If two events are not independent, then the occurrence of one of the events affects the chances
of occurrence of the other event.

As such, P(A | B) = P(A ᴖ B)/P(B)

Which can be rewritten to make P(A ᴖ B) the subject of the formula.

If A and B were independent, then P(A ᴖ B) = P(A) * P(B)

13. Use the following incomplete probability matrix to compute the joint probability of a
poor economy and an increase in interest rate:

Interest rates
Increase No increase

Economy Good 20% 10%

Normal 30% 20%

Poor X 10%

A. 0.2
B. 0.3
C. 0.1
D. 0.05
The correct answer is: C).

All the joint probabilities must add up to 1. Therefore, X

= 100% - 20% - 30% - 10% - 20% - 10%
= 10%

14. Calculate the probability that a stock return is either below -5% or above 5%, given:

P(R < -5%) = 16%

P(R > +5%) = 18%
A. 0.02
B. 0.32
C. 0.34
D. 0.16
The correct answer is: C).

Since the two events are mutually exclusive, the return cannot be below -5% or above 10% at the
same time. Therefore, the answer is simply 16% + 18% = 34%

Basic Statistics

15. Compute the sample standard deviation given the following sample data:

∑x = 31,353
n = 100
∑x2 = 10,687,041
A. 8654.64
B. 93
C. 313.53
D. 315
The correct answer is: B).

The formula for calculation of sample variance is s2 = 1/(n – 1)[∑x2 – n x̄2]

From the data, x̄ = 31353/100 = 313.53

s2 = 1/99[10,687,041 – 100 * 313.532] = 8654.64

The sample standard deviation = √s2 = √8654.64 = 93

16. On Tuesday, an insurance company receives a total of 10 claims for automobile policies.
After first round assessment, it’s found that the mean claim amount is $426 while the standard
deviation is 112. On Tuesday, the chief claims analyst authorizes the removal of one of the
claims for $545 from the list on grounds that it’s fraught with fraud. Compute the standard
deviation for the remaining set of 9 claims.
A. 110.2
B. 12145.2
C. 421.8
D. 420
The correct answer is: A).
∑x = the total of the original set of 10 claims = 426 * 10 = 4260
After removing the claim worth $545, the new value of ∑x = 4260 – 545 = 3,715
Thus, the new mean = 3715/9 = $412.8

Since s2 = 1/(n – 1)[∑x2 – nx̄2], using data for all the ten
claims, 1122 = 1/9[∑x2 – 10 * 4262]

Making ∑x2 the subject of the formula,

∑x2 = 1122 * 9 + 10 * 4262 = 1,927,656

Removing the fraudulent claim gives,

∑x2 = 1,927,656 – 5452 = 1,630,631

Now, using the data for the remaining 8 claims,

S2 = 1/(9 – 1)[1,630,631 – 9 * 412.82]
= 12,145.2

Therefore, s = √12,145.2 = 110.2

17. The following table presents the probability distribution of the earnings per share (EPS) for
a certain company:

Probability EPS Interest rates Beta

20% $1.5 21 1.15

10% $2.0 20% 10%

30% $1.3 20% 1.25

40% $1.2 10%

Compute the expected earnings per share.

A. 2
B. 1.5
C. 1.37
D. 1.2
The correct answer is: C).

EPS = E(X) = ∑P(xi)xi

= 0.2 * 1.5 + 0.1 * 2.0 + 0.3 * 1.3 + 0.4 * 1.2
= 1.37
18. A renowned economist has calculated that the Canadian economy will be in one of 3
possible states in the coming year: Boom, Normal, or Slow. The following table gives the
returns of stocks A and B under each economic state.

State Probability(state) Return for stock A Return for stock B

Boom 40% 12% 18%

Normal 35% 10% 15%

Slow 25% 8% 12%

Which of the following is closest to the covariance of the returns for stocks A and B?
A. 0.103
B. 0.0001734
C. 0.1545
D. 0.0003765

The correct answer is: D).

Cov(A, B) = ∑P(s) * [RA – E(RA)] * [RB – E(RB)]

First, you have to determine the expected return for every stock:
E(RA) = 0.4 * 0.12 + 0.35 * 0.1 + 0.25 * 0.08 = 0.103
E(RB) = 0.4 * 0.18 + 0.35 * 0.15 + 0.25 * 0.12 = 0.1545

State P(S) RA RBP(S) * [RA – E(RA)] * [RB

– E(RB)]
Boom 0.4 0.12 0.18 0.4 * [0.12 – 0.103] * [0.18 – 0.1545] = 0.0001734
Normal 0.35 0.1 0.15 0.35 * [0.1 – 0.103] * [0.15 – 0.1545] = 0.000004725
Slow 0.25 0.08 0.12 0.25 * [0.08 – 0.103] * [0.12 – 0.1545] = 0.0001984
Cov(A, B) = 0.0001734 + 0.000004725+ 0.0001984
= 0.0003765

19. Which of the following statements is NOT true regarding the correlation coefficient?
A. The correlation coefficient measures the strength of the linear relationship between two
random variables
B. The correlation coefficient has no units
C. The correlation coefficient ranges from 0 to +1
D. Random variables with a correlation of +1 are said to be perfectly correlated
The correct answer is: C).

In finance, the correlation coefficient attempts to measure the degree to which two random
variables, say, returns for different stocks move in relation to each other. The correlation coefficient
always lies between -1 and +1. A positive value indicates that the random variables move in the
same direction i.e. if an increase (decrease) is recorded in one variable, we expect an increase
(decrease) in the other variable, which can either be proportionate or disproportionate depending on
the value of the correlation.

20. A discrete random variable Y has probability function given by:

Y 0 1 2

P(Y = y) 0.3 0.6 0.1

Calculate Var(Y).
A. 0.2
B. 0.36
C. 0.8
D. 1
The correct answer is: B).

The variance of any given random variable is given by:

Var(Y) = E(Y2) - E2(Y)

E(Y) = ∑YP(Y =y) = 0 * 0.3 + 1 * 0.6 + 2 * 0.1 = 0.8

E(Y2) = ∑Y2P(Y =y) = 02 * 0.3 + 12 * 0.6 + 22 * 0.1 = 1

Therefore, Var(Y) = 1 - 0.82 = 0.36

21. The mean height of female FRM exam candidates over the years is 1.671m while that of
male candidates is 1.757. Given that the mean height of ALL of the exam candidates is
1.712m, calculate the percentage of the candidates who are female:
A. 0.523
B. 0.46
C. 0.087
D. 0.477
The correct answer is: A).

Let F be the proportion of females.

Applying the idea of a weighted mean,

1.671F + 1.757(1 – F) = 1.712
1.671F + 1.757 – 1.757F = 1.712
1.757 -1.712 = 1.757F - 1.671F
0.045 = 0.086F
F = 0.523 or 52.3%
22. Two random variables X and Y are such that V[X] = 4V[Y] and Cov[X,Y] =

V[Y] Let E = X + Y and F = X – Y

Find Cov[E, F]
A. V[Y] – V[X]
B. Cov[X,Y]
C. V[Y]
D. 3V[Y]
The correct answer is: D).

Cov[E,F] = Cov[X + Y,X – Y]

= Cov[X,X] – Cov[X,Y] + Cov[Y,X] – Cov[Y,Y]
= V[X] – V[Y]
= 4V[Y] – V[Y]
= 3V[Y]

Logic applied:
I. Given a random variable X, the covariance between X and itself is simply its
variance II. Cov[X,Y] = Cov[Y,X]

23. Let Y be a discrete random variable with the following probability distribution:

Y 0 1 2 3

P(Y = y) 0.3 0.2 0.4 0.1

Determine the variance of X, where X = 2Y + 10

A. 1.7
B. 2.7
C. 4
D. 14
The correct answer is: C).

V[X] = V[2Y + 10]

= 4V[Y]

V[Y] = E[Y2] – E2Y

= 0.3 * 02 + 0.2 * 12 + 0.4 * 22 + 0.1 * 32 – [0.3 * 0 + 0.2 * 1 + 0.4 * 2 + 0.1 * 3] 2

= 2.7 – 1.7
=1

Hence V[X] = 4V[Y] = 4 * 1 = 4

Logic applied:
I. V[aX] = a2V[X]
II. V[X ± a] = V[X]
Where X is a random variable and a is a constant.

24. Which of the following best describes the concept of skewness in statistics?
A. The degree to which a distribution is symmetric about its mean

B. The degree to which a distribution is nonsymmetric about its median

C. The degree to which a distribution is nonsymmetric about its mean
D The degree to which a random variable spreads around its mean
The correct answer is: C).

Skewness in statistics describes the asymmetry from the normal distribution in a set of data. Such
a dataset differs from a normal curve which is bell-shaped and perfectly symmetrical. In layman’s
language, a symmetrical curve can be divided into two equal halves with the mean at the middle.
When this is not possible, the curve (and the underlying data) is said to be skewed. A distribution
can either be positively or negatively skewed, depending on where there’s a higher concentration of
data points.

25. Which of the following is incorrect about kurtosis?

A. Excess kurtosis is a measure relative to the uniform distribution, which has a kurtosis of
3 B. Excess kurtosis that’s negative indicates a platykurtic distribution

C. Excess kurtosis that’s positive indicates a leptokurtic

distribution D. The normal distribution has a kurtosis equal to 3
The correct answer is: A).
Kurtosis basically measures the peakedness of a distribution. Data sets with a high kurtosis tend to
have many data points at the tails (outliers). Kurtosis is measured relative to the normal
distribution, which has a kurtosis of exactly 3.

26. Mary, FRM, is tasked with analyzing the returns of two different assets – A and B. She
finds that the two assets have the same mean, variance, and skewness, but A has a higher
kurtosis than B. Which of the following statements is most likely true?
A. Asset A is riskier than asset B
B. Asset B is riskier than asset A
C. Both assets are highly profitable
D. Assets A and B will earn equal returns in the long term
The correct answer is: A).

In finance, Kurtosis affects the riskiness of an asset. The asset with a higher kurtosis is considered
riskier than another one with a lower kurtosis. The underlying logic is that a high kurtosis indicates a
high number of outliers, meaning that the return for such an asset is highly variable, and therefore
highly risky.

27. The following are measures of variability,

EXCEPT: A. Variance

B. Standard
deviation C. Range
D. Median
The correct answer is: D).

The mean, median, and the mode are all measures of central tendency – all of them attempt to
describe data by identifying a central position. Measures of variation such as variance describe
the spread of the data around the mean.

28. Two stocks, X and Y, have a correlation of 0.50. Stock Y’s return has a standard deviation of
0.26. Given that the covariance between X and Y is 0.005, determine the variance of returns
for stock X
A. 0.13
B. 0.00148
C. 0.0385
D. 0.0148
The correct answer is: B).
Correlation between X and Y,
Corr(X,Y) = Cov(X,Y)/(sX * sY)
0.50 = 0.005/(σX * 0.26)
0.13σX = 0.005
σX = 0.0385

V(X) = 0.03852 = 0.00148

29. Which of the following best describes the concept of an unbiased estimator?
A. One for which the accuracy of the parameter estimate increases as the sample
size increases
B. One that has the least variance compared to all other estimators
C. One for which the accuracy of the parameter estimate increases as the sample
size decreases
D. One for which the expected value of the estimator is equal to the value of the parameter
being estimated
The correct answer is: D).

If x̄ is an unbiased estimator of μ, then the expected value of x̄ is equal to μ.

Distributions

30. During a disease outbreak, the probability of surviving after infection is 60%. Determine
the probability that at least 8 out of a group of 9 infected persons will survive?
A. 0.7
B. 0.07
C. 0.007
D. 0.06
The correct answer is: B).

We note the following:

I. That the infection of any single individual is independent of all other infections for other
individuals. II. The trials are identical (Probability of survival is 60% every time)

Therefore, the number of survivors takes on a binomial distribution with n = 9 and θ = 0.6

If X stands for the number of survivors, then:

P(X ≥ 8) = P(X=8 or 9) = 9C8 * 0.68 * 0.4 + 9C9 * 0.69
= 9 * 0.017 * 0.4 + 1 * 0.01
= 0.070 or 7%
31. Luke Friday, FRM, runs a consultancy firm that offers investment advice to clients around
Los Angeles. The number of clients the firm receives in a month is distributed as a Poisson
variable with a mean of 2. What is the probability that the firm receives exactly 30 new clients
in a year, assuming every client is independent?
A. 0.025
B. 0.0363
C. 0.24
D. 0.00363
The correct answer is: B).

We note the following:

I. New clients are received randomly at a rate of 2 per unit time (month)
II. Each event is independent

These observations confirm the Poisson distribution.

Since the question asks us to find a yearly probability, we must convert the monthly Poisson rate
to an equivalent yearly rate.

Poi(2) monthly distribution is equivalent to Poi(24)

Now, if X stands for the number of clients received,

P(X = x) = [exp(-λ) λ x]/x!
P(X = 30) = [exp(-24) 2430]/30!
= 0.0363

32. Which of the following is NOT true regarding the normal distribution?

A. It’s completely described by its mean, μ, and variance, σ2

B. Its skewness = 3 and kurtosis = 0
C. A linear combination of two normally distributed variables also has a normal distribution
D. The probabilities of extreme events (those further above and below the mean) continually get
smaller but extend infinitely without going to zero
The correct answer is: B).

Statement B is false but its converse is true: The normal distribution has skewness = 0 and kurtosis
= 3. In fact, the kurtosis of other distributions is measured relative to 3, which is the kurtosis of
the normal distribution.

33. Consider the following events:

I. Throwing a fair, six-sided die

II. The rate at which customers walk into a banking hall per day
III. The score of 50 FRM exam candidates in a mock test
IV. Tossing a coin
V. Picking of an orange from a basket containing 10 equally sized oranges

Which of the events above exhibit uniform distributions?

A. I, IV, and V
B. I and II only
C. II and III only
D. None of the above
The correct answer is: A).

Under the uniform distribution, ALL outcomes are equally likely i.e., they have equal probabilities
of occurrence. For example, if we were to throw a fair die, each of numbers 1 to 6 would have a
probability of 1/6. Similarly, a head (or a tail) occurs with probabilities of 0.5 when a coin is tossed.

34. The probability that a patient suffering from typhoid will be treated successfully is 0.8.
40 patients are subjected to treatment. Determine the expected value of the number of
patients who are treated successfully.
A. 7
B. 28
C. 8
D. 32
The correct answer is: D).

This question tests the knowledge of the mean of the binomial distribution (n, θ)

The expected number of cured patients = E(X) = nθ = 40 * 0.8 = 32

Note that V(X) = nθ (1 – θ)

35. The rate of registration for the FRM exam by candidates takes on a Poisson distribution
with mean λ. Which of the following statements is correct?
A. Mean equals the standard deviation
B. Mean equals the variance
C. Median equals the variance
D. Median, mean and variance are all equal
The correct answer is: B).
An interesting fact about the poisson distribution is that the mean equals the variance.

36. A vehicle repairs assembly has a total of 100 jerks and other repair work machines in
constant use. The probability of a machine breaking down during a given day is 0.004. There
are days when none of the machines break down. However, during some days, one, two,
three, four, or more machines break down. Calculate the probability that fewer than 3 machines
break down during a particular day.
A. 0.007726
B. 0.6698
C. 0.9923
D. 0.269
The correct answer is: C).

The number of breakdowns takes on a binomial distribution with n = 100 and θ = 0.004

“Fewer than 3” implies 0, or 1, or 2 machines break down

Therefore,
P(fewer than 3) = P(0 breakdowns) + P(1 breakdowns) + P(2 breakdowns)
= 100C0 * 0.0040 * 0.996100 + 100C1 * 0.0041 * 0.99699 + 100C2 * 0.0042 * 0.99698
= 0.6698 + 0.2690 + 0.05347
= 0.9923

37. In the standard normal distribution, what do z-scores represent?

A. Scores below and above the mean in units of the standard deviation of the distribution
B. Scores below and above the variance in units of the standard deviation of the distribution
C. Scores above the mean in units of the standard deviation of the distribution from the mean

D. Scores below and above the mean in units of the standard deviation of the distribution
from the mean
The correct answer is: D).

The z-score is calculated as (X – μ)/ σ

It therefore gives the location of raw scores above and below the mean in units of the
standard deviation of the distribution from the mean.

38. The random variable X denotes (in units of $100,000) the size of loss per project incurred
in a particular investment company. In addition, assume that X follows a chi-square distribution
with 2 degrees of freedom. A risk manager randomly chooses two such projects and further
assumes that their corresponding losses are independent of each other. Calculate the mean
and variance of the total loss from the two projects.
A. Mean = 400,000; variance = 8 * 1010
B. Mean = $400,000; variance = $8 * 1010
C. Mean = 400,000; variance = 800,000
D. Mean = $400,000; variance = $800,000
The correct answer is: B).

It’s imperative to note the following: A random variable that follows the chi-square distribution has
a mean of n and a variance of 2n, where n is the number of degrees of freedom. We could
approach the question from two different perspectives:

1. Summation of independent variables Since n

= 2, E(Xi) = 2, and Var(Xi) = 4 X1 and X2 are
independent, which means: E(X1 + X2) = 4, and
Var(X1 + X2) = 8 Therefore, for the total loss from
the two projects,
Mean = 4 * 100,000 = $400,000 while Variance = $8 * 1010 (we have to square up the dollar - $2)

2. Summation of two chi-square random variables

If A and B are two chi-square random variables with m and n degrees of freedom respectively, then
the sum of A and B is ALSO a chi-square variable with m + n degrees of freedom.
Therefore, X1 + X2 = X4
Working out the problem with this result (X4) gives the same values as above.

39. Which of the following best describes the central limit theorem?
A. When the sample size is large, the sum of independent and identically distributed
(i.i.d.) random variables are normally distributed
B. The sum of n independent and identically distributed random variables approaches
the normal distribution as n becomes large

C. For simple random samples of size n from a population with mean μ and finite variance σ2,
the sampling distribution approaches the normal distribution with mean μ and variance σ2/n,
as the sample size becomes large
D. For simple random samples of size n from a population with mean µ and finite variance
σ2, the sampling distribution of the sample mean approaches the normal distribution with
mean μ and variance σ2/n, as the sample size becomes large
The correct answer is: D).

The Central Limit Theorem states that the sampling distribution of the sample means approaches a
normal distribution as the sample size gets larger — no matter what the shape of the population
distribution. This fact holds especially true for sample sizes over 30. All this is saying is that as you take
more samples, especially large ones of size 30 or more, your graph of the sample means will look more
like a normal distribution. Please note that it's the sample mean that's normally distributed, not the sample
itself. This is why option C is incorrect. This handy result considerably simplifies computation of
probabilities and construction of statistical hypothesis. So long as we have sample
statistics, we can draw relevant conclusions about the actual population regardless of the
population’s distribution, provided n is sufficiently large (n is usually taken to be ≥ 30).

40. The marketing department of a large mutual fund estimates that 82% of all new employees
put on probation for the first year eventually get fully employed. During a recent recruitment
drive, a total of 280 new employees were recruited. Approximate the probability that at least
240 of these will eventually earn themselves permanent roles in the company after one year.
A. 0.062
B. 0.18
C. 0.9382
D. 0.82
The correct answer is: A).

If we let X to be the number of employees who get fully employed:

X follows a binomial distribution with mean (θ) 0.82 and n = 280 i.e. X∿bin(280, 0.82)

We want to find P(X ≥ 240)

It would take a lot of time to compute P(X = 240, X = 241 … X = 280). Thanks to the central limit theorem, we can approximate the binomial
distribution in terms of the normal distribution, whereby: X∿bin(280, 0.82) ≈ N(229.6, 6.432)
where mean becomes nθ while variance becomes nθ(1 – θ)

Now, P(X ≥ 240) = P(X > 239.5) applying continuity correction as a result approximating a
discrete distribution (binomial) with a continuous distribution (normal)

= P[Z > (239.5 – 229.6)/6.43] = P(Z > 1.54) = 1 – 0.93822 = 0.062 (read off the normal distribution
table)

41. The normal distribution and the lognormal distribution are related in such way that: A.

If a random variable X follows a lognormal distribution, ln X is normally distributed

B. If a random variable X follows a normal distribution, ln X is said to have a lognormal

distribution

C. The mean and variance of a lognormal distribution are twice that of the normal
distribution, provided the value of n is the same
D. The mean and variance of the normal distribution are twice that of the lognormal distribution,
provided the value of n is the same
The correct answer is: A).

A random variable X follows a lognormal distribution if its natural logarithm, ln X, is normally

distributed. In layman’s language (for easy understanding), you can view the term “lognormal”
as “the log is normal”.
42. A motor vehicle production company based in California is assembling its first batch of fully
electric cars. After inspecting about 100 newly assembled units, engineers establish that 40 of
them have mechanical defects. While some units have no defects, others have one, two, or
more defects. Assume that the distribution of mechanical defects follows a Poisson
distribution. Drawing on the first 100 units produced, how many cars, out of every 10,000 units
assembled, would we expect to have at least one defect?
A. About 330
B. About 0.330
C. About 3,300
D. About 1250
The correct answer is: C).

Let’s use X to denote the number of defects in a car.

X∿Poi(40/100) i.e. λ = 0.4

P(X is at least 1) = 1 – P(X = 0)

= 1 – exp(-0.4) = 0.330

This is the probability of at least 1 defect in a car. Therefore, for every 10,000 cars, we would expect
0.330 * 10,000 = 3,300 units to have one or more defects.

43. The F-distribution and the Chi-square distribution have glaring similarities. Which of
the following is not accurate?
A. Both are asymmetrical
B. Both have a bound equal to zero on the left
C. Their means are always less than their standard deviations
D. They are defined by the number of degrees of freedom
The correct answer is: C).

There exists no consistent relationship between mean and standard deviation in either the F- or the
chi-square distribution.

44. Insurance claims in a certain class of business are modeled using a normal distribution with
mean $3,000 and standard deviation $400. Calculate the probability that the next claim
received will exceed $3,500.
A. 0.8944
B. 0.25
C. 0.75
D. 0.1056
The correct answer is: D).
X∿N(3000, 4002)

P(X > 3500) = P[Z > (3500 – 3000)/400]

= P(Z > 1.25)
= 1 –P(Z < 1.25)

=1 - 0.8944
= 0.1056

Bayesian Analysis

45. The punctuality of filing tax returns has been investigated by considering a number of
citizens in different geographical regions. In the sample, 60 % of respondents were from Africa,
20% Europe, and 20% South America. The probabilities of late filing of returns in Africa, Europe,
and South America are 45%, 15%, and 20% respectively.

If a late submitter is picked at random from the area under study, what is the probability
that they are from Africa?
A. 0.7941
B. 0.0794
C. 0.34
D. 0.27
The correct answer is: A).

Let ‘A’ be the event that an individual chosen at random comes from Africa. Let ‘E’ and ‘S’ have
similar definitions for Europe and South America respectively.

Define ‘L’ as the event that an individual chosen at random submits tax returns late.

Now, we wish to determine P(Africa | Late) = P(A | L)

Applying Bayes Theorem,

P(A| L) = (P(A) * P(L | A))/ [P(A) * P(L | A) + P(E) * P(L | E) + P(S) * P(L | S)]
= 0.6 * 0.45/[(0.6 * 0.45) + (0.2 * 0.15) + (0.2 * 0.20]
= 0.27/[0.27 + 0.03 + 0.04]
= 0.7941

46. A financial risk manager has three routes to get to the office. The probability that she gets
to the office on time using routes X, Y, and Z are 60%, 65%, and 70%. She does not have a
preferred route and is therefore equally likely to choose any of the three routes. Calculate the
probability that she chose route Z given that she arrives to work on time.
A. 0.359
B. 0.233
C. 0.216
D. 0.2
The correct answer is: A).

Define X to be the event “chooses route X” Let Y and Z have similar definitions.

Define O to be the event that she arrives on time

We wish to determine P(Z | O). Then:

P(Z | O) = P(Z) * P(O | Z)/ [P(Z) * P(O | Z) + P(Y) * P(O | Y) + P(X) * P(O| X)]
= (1/3 * 0.7)/[(1/3 * 0.7) + (1/3 * 0.65) + (1/3 * 0.6)
= 0.2333/(0.2333 + 0.2167 + 0.2)
= 0.3589

47. Common Text for Questions 357, 358, 359, and 360
A life assurance company insures individuals of all ages. A manager compiled the
following statistics of the company’s insured persons:

Age of Mortality (Probability of Portion of company’s

insured death)[arbitrary] insured persons

16-20 0.04 0.1

21-30 0.05 0.29

31-65 0.10 0.49

66-99 0.14 0.12

If a randomly selected individual insured by the company dies, calculate the probability that
the dead client was age 16-20.
A. 0.04
B. 0.048
C. 0.046
D. 0.047
The correct answer is: D).
Define the following events:
B = Event of death
B1= Event the insured’s age is in the range 16-20
B2= Event the insured’s age is in the range 21-30
B3= Event the insured’s age is in the range 31-65
B4= Event the insured’s age is in the range 66-99

We wish to determine P(B1 | B)

P(B1 | B) = (P(B1) * P(B | B1))/[ P(B1) * P(B | B1) + (P(B2) * P(B | B2) + (P(B3) * P(B | B3) + (P(B4) *
P(B | B4)]
= (0.1 * 0.04)/[(0.1 * 0.04) + (0.29 * 0.05) + (0.49 * 0.1) + (0.12 * 0.14)
= 0.004/(0.004 + 0.0145 + 0.049 + 0.0168)
= 0.04745 or 4.7%

48. A life assurance company insures individuals of all ages. A manager compiled the
following statistics of the company’s insured persons:

Age of Mortality (Probability of Portion of company’s

insured death)[arbitrary] insured persons
16-20 0.04 0.1
21-30 0.05 0.29

31-65 0.10 0.49

66-99 0.14 0.12

If a randomly selected individual insured by the company dies, calculate the probability that
the dead client was in age range 21-30.
A. 0.172
B. 0.04
C. 0.168
D. 0.145
The correct answer is: A).

We wish to determine P(B2 | B)

P(B2 | B) = (P(B2) * P(B | B2))/[ P(B2) * P(B | B2) + (P(B1) * P(B | B1) + (P(B3) * P(B | B3) + (P(B4) *
P(B | B4)]
= (0.29 * 0.05)/[(0.29 * 0.05) + (0.1 * 0.04) + (0.49 * 0.1) + (0.12 * 0.14)
= 0.0145/(0.0145 + 0.004 + 0.049 + 0.0168)
= 17.2%
49.
A life assurance company insures individuals of all ages. A manager compiled the
following statistics of the company’s insured persons:

Age of Mortality (Probability of Portion of company’s

insured death)[arbitrary] insured persons

16-20 0.04 0.1

21-30 0.05 0.29

31-65 0.10 0.49

66-99 0.14 0.12

Compute the probability that the dead client was in age range 31-65.
A. 0.58
B. 0.172
C. 0.168
D. 0.047

The correct answer is: A).

We wish to determine P(B3 | B)

P(B3 | B) = (P(B3) * P(B | B3))/[ P(B3) * P(B | B3) + (P(B1) * P(B | B1) + (P(B2) * P(B | B2) + (P(B4) *
P(B | B4)]
= (0.49 * 0.10)/[0.49 * 0.10 + 0.1 * 0.04 + 0.29 * 0.05 + 0.12 *0.14]
= 0.049/(0.049 + 0.004 + 0.0145 + 0.0168)
= 58%

50. A life assurance company insures individuals of all ages. A manager compiled the
following statistics of the company’s insured persons:

Age of Mortality (Probability of Portion of company’s

insured death)[arbitrary] insured persons
16-20 0.04 0.1
21-30 0.05 0.29
31-65 0.10 0.49
66-99 0.14 0.12

Calculate the probability that the dead client was between 66 and 99 years.
A. 0.047
B. 0.172
C. 0.12
D. 0.201

The correct answer is: D).

Define the following events:

B = Event of death
B1= Event the insured’s age is in the range 16-20
B2= Event the insured’s age is in the range 21-30
B3= Event the insured’s age is in the range 31-65
B4= Event the insured’s age is in the range 66-99

P(B1 | B) = (P(B1) * P(B | B1))/[ P(B1) * P(B | B1) + (P(B2) * P(B | B2) + (P(B3) * P(B | B3) + (P(B4) *
P(B | B4)]
= (0.1 * 0.04)/[(0.1 * 0.04) + (0.29 * 0.05) + (0.49 * 0.1) + (0.12 * 0.14)
= 0.004/(0.004 + 0.0145 + 0.049 + 0.0168)
= 0.04745 or 4.7%
P(B2 | B) = (P(B2) * P(B | B2))/[ P(B2) * P(B | B2) + (P(B1) * P(B | B1) + (P(B3) * P(B | B3) + (P(B4) *
P(B | B4)]
= (0.29 * 0.05)/[(0.29 * 0.05) + (0.1 * 0.04) + (0.49 * 0.1) + (0.12 * 0.14)
= 0.0145/(0.0145 + 0.004 + 0.049 + 0.0168)
= 17.2%
P(B3 | B) = (P(B3) * P(B | B3))/[ P(B3) * P(B | B3) + (P(B1) * P(B | B1) + (P(B2) * P(B | B2) + (P(B4) *
P(B | B4)]
= (0.49 * 0.10)/[0.49 * 0.10 + 0.1 * 0.04 + 0.29 * 0.05 + 0.12 *0.14]
= 0.049/(0.049 + 0.004 + 0.0145 + 0.0168)
= 58%
P(B4 | D) = 100 – 58 – 17.2 – 4.7 = 20.1% (Sum of all the probabilities must add up to 1).

51. An investment firm classifies capital projects into three different categories, depending on
risk level: Standard, Preferred, and Ultra-preferred. Of the firm’s projects, 60% are standard,
30% are preferred, and 10% are ultra-preferred. The probabilities of a project making a loss
are 0.01, 0.005, and 0.001 for categories standard, preferred, and ultra-preferred respectively.

If a capital project makes a loss in the next year, then what is the probability that the project
was standard (correct to 2 decimal places)?
A. 0.79
B. 0.7895
C. 0.22
D. 0.15
The correct answer is: A).
Let:
L = Event a project makes a loss
S = Event of a standard project
P1 = Event of a preferred project
U = Event of a ultra-preferred project

We wish to determine P(S | L)

P(S | L) = (P(S) * P(L | S))/ [P(P1) * P(L | P1) + P(U) * P(L | U)]
= (0.6 * 0.01)/[(0.6 * 0.01) + (0.3 * 0.005) + (0.1 * 0.001)]
= 0.006/[0.006 + 0.0015 + 0.0001]
= 0.7895 or 79%

52. Upon arrival at a cancer treatment center, patients are categorized into one of four
stages namely: stage 1, stage 2, stage 3, and stage 4. In the past year,

i. 10% of patients arriving were in stage 1

ii. 40% of patients arriving were in stage 2
iii. 30% of patients arriving were in stage 3
iv. The rest of the patients were in stage 4
v. 10% of stage 1 patients died
vi. 20% of stage 2 patients died
vii. 30% of stage 3 patients died
viii. 50% of stage 4 patient died

Given that a patient survived, what is the probability that the patient was in stage 4 upon
arrival? (correct to 2 decimal places)
A. 0.13
B. 0.14
C. 0.138
D. 0.139
The correct answer is: B).

Let:
D = Event of death of a cancer patient
C1 = event of stage 1 cancer
C2 = event of stage 2 cancer
C3 = event of stage 3 cancer
C4 = event of stage 4 cancer

We wish to determine P(C4 | D’) where D’ denotes survival

P(C4 | D’) = (P(C4) * P(D’ | C4))/[ (P(C4) * P(D’ | C4) + ((P(C1) * P(D’ | C1) + (P(C2) * P(D’ | C2) +
(P(C3) * P(D’ | C3)
= (0.2 * 0.5)/[(0.2 * 0.5) + (0.1 * 0.9) + (0.4 * 0.8) + (0.3 * 0.7)
= 0.1/(0.1 + 0.09 + 0.32 + 0.21)
= 14%
53. Upon arrival at a cancer treatment center, patients are categorized into one of four stages
namely: stage 1, stage 2, stage 3, and stage 4. In the past year,

i. 10% of patients arriving were in stage 1

ii. 40% of patients arriving were in stage 2
iii. 30% of patients arriving were in stage 3
iv. The rest of the patients were in stage 4
v. 10% of stage 1 patients died
vi. 20% of stage 2 patients died
vii. 30% of stage 3 patients died
viii. 50% of stage 4 patient died

Given that the patient died, what is the probability that the patient was in stage 4 cancer?
A. 0.86
B. 0.1
C. 0.36
D. 0.5

The correct answer is: C).

We wish to determine P(C4 | D)

P(C4 | D) = (P(C4) * P(D | C4))/[ (P(C4) * P(D | C4) + ((P(C1) * P(D | C1) + (P(C2) * P(D | C2) +
(P(C3) * P(D | C3)
= (0.2 * 0.5)/[(0.2 * 0.5) + (0.1 * 0.1) + (0.4 * 0.2) + (0.3 * 0.3)]
= 0.1/(0.1 + 0.01 + 0.08 + 0.09)
= 36%

54. You are an analyst at a large mutual fund. After examining historical data, you establish
that all fund managers fall into 2 categories: superstars (S) and ordinaries (O).

Superstars are by far the best managers. The probability that a superstar will beat the market
in any given year stands at 70%. Ordinaries, on the other hand, are just as likely to beat the
market as they are to underperform it. Regardless of the category in which a manager falls, the
probability of beating the market is independent from year to year. Superstars are rare
diamonds because only a meager 16% of all recruits turn out to be superstars.

During the analysis, you stumble upon the profile of a manager recruited 3 years ago, who
has since gone on to beat the market every year.

Determine the probability that the manager was a superstar when he was recruited into
the fund.
A. 0.5
B. 0.86
C. 0.7
D. 0.16
The correct answer is: D).

Let:
B = Event that a manager beats the market
S = Event that a superstar is recruited

Therefore,
P(B | S) = 70% = 7/10
P(B | O) = 50% = 1/2
At the time of recruitment, the probability of the manager being a superstar was just
the unconditional probability of a manager being a superstar i.e. P(S) = 16%

55. You are an analyst at a large mutual fund. After examining historical data, you establish
that all fund managers fall into 2 categories: superstars (S) and ordinaries (O).

Superstars are by far the best managers. The probability that a superstar will beat the market
in any given year stands at 70%. Ordinaries, on the other hand, are just as likely to beat the
market as they are to underperform it. Regardless of the category in which a manager falls, the
probability of beating the market is independent from year to year. Superstars are rare
diamonds because only a meager 16% of all recruits turn out to be superstars.

During the analysis, you stumble upon the profile of a manager recruited 3 years ago, who
has since gone on to beat the market every year.

What is the probability that the manager is a superstar as at present?

A. 0.46
B. 0.34
C. 0.84
D. 0.16
The correct answer is: B).

We need to determine P(S | 3B): The probability that the manager is a superstar given that they
have managed to beat the market in three consecutive years. As such, we need to apply
Bayes' theorem.

P(S | 3B) = P(S) * P(3B | S)/P(3B)

Now, we already have P(S) = 16% = 4/25

P(3B | S) = (7/10)3 since performance is independent from one year to the next
= 343/1000

P(3B) = unconditional probability of beating the market in 3 consecutive years

= weighted average probability of 3 marketing-beating years over both superstars and ordinaries
= P(3B | S) * P(S) + P(3B | O) * P(O)
= [(7/10) )3 * 4/25] + [(1/2) )3 * 21/25]
= (343/1000 * 4/25) + (1/8 * 21/25)
= 1372/25000 + 21/200
= 16%

Therefore,
16%*34.3%/16% = 34.3% or 0.343

56. You are an analyst at a large mutual fund. After examining historical data, you establish that
all fund managers fall into 2 categories: superstars (S) and ordinaries (O).

Superstars are by far the best managers. The probability that a superstar will beat the market
in any given year stands at 70%. Ordinaries, on the other hand, are just as likely to beat the
market as they are to underperform it. Regardless of the category in which a manager falls, the
probability of beating the market is independent from year to year. Superstars are rare
diamonds because only a meager 16% of all recruits turn out to be superstars.

During the analysis, you stumble upon the profile of a manager recruited 3 years ago, who
has since gone on to beat the market every year.

What is the probability that the manager is NOT a superstar?

A. 0.66
B. 0.7
C. 0.45
D. 0.64
The correct answer is: A).

Since we already have the probability that the manager is a superstar now, the remaining
probability is surely the likelihood of the manager not being a superstar. i.e. being ordinary.

P(O | 3B) = 1 – P(S | 3B)

57. A human health organization tracked a group of individuals for 5 years. At the
commencement of the study, 25% were categorized as heavy smokers, 40% as light
smokers and the remaining as nonsmokers. Results revealed that light smokers were twice
as likely as nonsmokers to die during the half-decade study, but only half as likely as heavy
smokers. During the period, a randomly selected group member passed on.
Compute the probability that the individual who died was a heavy smoker.
A. 0.19
B. 0.53
C. 0.47
D. 0.175
The correct answer is: C).

Let:
D = Event of death
L = Event of light smoker
H = Event of heavy smoker
N = Event of nonsmoker

We need to calculate P(H | D)

Now, we already know that:

P(D | L) = 2P(D | N) and P(D | L) = 1/2P(D | H)

Applying Bayes’ theorem,

P(H | D) = (P(H) * P(D | H))/[(P(H) * P(D | H) + P(L) * P(D | L) + P(N) * P(D | N)]
= (2P(D | L) * 0.25)/[ (2P(D | L) * 0.25) + P(D | L) * 0.4 + 1/2P(D | L) * 0.35]
= 0.5/(0.5 + 0.175 + 0.4)
= 0.4651

58. Which of the following best describes the difference between the Bayesian approach and
the frequentist approach?

A. The Bayesian approach is based on a prior belief regarding the probability of occurrence of
an event
B. The frequentist approach is based on a prior belief regarding the probability of occurrence of
an event

C. The Bayesian approach is applicable with both small and large sample sizes while
the frequentist approach is only applicable with large sample sizes

D. While the Bayesian approach is based on a prior belief regarding the probability of
occurrence of an event, the frequentist approach involves drawing conclusions from
sample data using the frequency of the data
The correct answer is: D).

The Bayesian approach draws on a prior belief regarding the probability of an event occurring. The
frequentist approach, on the other hand, draws on the frequency of events occurring during the
most recent sample.
59. Peter selects a coin from a pair of coins and tosses it. While coin 1 is double-headed, coin 2
is a normal unbiased coin. After the toss, the result is a head. Calculate the probability that it
was coin 1 which was tossed.
A. 1/3
B. 2/3
C. 0.5
D. 0.75
The correct answer is: B).

We need to determine P(coin 1 | head). By applying Bayes’ theorem,

P(coin 1 | head) = P(coin 1) * P(head | coin 1)/[ P(coin 1) * P(head | coin 1) + P(coin 2) * P(head |
coin 2)
= (1 * 1/2)/[1 * 1/2 + 1/2 * 1/2 ]
= 2/3

60.The Y variable is regressed against the X variable resulting in a regression line that is flat
with the plot of the paired observations widely dispersed about the regression line. Based on
this information, which statement is most accurate?

A) X is perfectly positively correlated to Y.

B) The correlation between X and Y is close to zero.
C) X is perfectly negatively correlated to Y.
D) The R2 of this regression is close to 100%.

Answer is B

Perfect correlation means that the observation fall on the regression line .+ means the line is
going up and – means it is pointed down .An R2 of 100% means perfect correlation. When
there is no correlation, the regression line is flat and residual standard error equals the standard
deviation of Y.