CFA 8: Probability Concepts

Question 1

random variable

Probability, Expected Value, and Variance

Answer 1

A quantity whose outcomes are uncertain.

Question 2

outcomes

Probability, Expected Value, and Variance

Answer 2

Possible values

Question 3

event

Probability, Expected Value, and Variance

Answer 3

A specified set of outcomes.

Question 4

probability

Probability, Expected Value, and Variance

Answer 4

A number between 0 and 1 that measures the chance taht a stated event will occur.

Question 5

pairs arbitrage trade

Probability, Expected Value, and Variance

Answer 5

A trade in two closesly related stocks involving the short sale of one and the purchase of the other.

Question 6

Dutch Book Theorem

Probability, Expected Value, and Variance

Answer 6

A result in probability theory stating that inconsistent porbabilities create profit opportunities.

Question 7

unconditional probability

Probability, Expected Value, and Variance

Answer 7

The probability of an event NOT conditioned on another event.

Question 8

conditional probability

Probability, Expected Value, and Variance

Answer 8

The conditional probability of A given that B has occurred is equal to the join probability of A and B divided by the probability of B (assumed not to equal 0).

Question 9

joint probability

Probability, Expected Value, and Variance

Answer 9

The probability of the joint occurrence of stated events.

Question 10

addition rule for probabilities

Probability, Expected Value, and Variance

Answer 10

A principle stating that the probability that A or B occurs (both occur) equals the probability that A occurs, plus the probability that B occurs, minus the probability that both A and B occur

Question 11

independent events

Probability, Expected Value, and Variance

Answer 11

Two events are independent if and only if P(A | B) = P(A) or, equivalently, P(B | A) = P(B).

Question 12

dependent events

Probability, Expected Value, and Variance

Answer 12

When two events are not independent. The probability of occurence of one is related to the occurrence of the other.

Question 13

expected value of a random variable

Probability, Expected Value, and Variance

Answer 13

The expected value of a random variable is the probability-weighted average of the possible outcomes of the random variable. For a random variable X, the expected value of X is denoted E(X).

Question 14

conditional expected values

Probability, Expected Value, and Variance

Answer 14

The expected value of a stated event given that another event has occured.

Question 15

total probability rule for expected value

Probability, Expected Value, and Variance

Answer 15

A rule explaining the expected value of a random variable in terms of expected values of the random variable conditional on mutually exclusive and exhaustive scenarios.

Question 16

conditional variances

Probability, Expected Value, and Variance

Answer 16

The variance of one variable given the outcome of another.

Question 17

Properties of Correlation

Portfolio Expected Return and Variance of Return

Answer 17

1) Correlation is a number between -1 and +1 for two random variables, X and Y:
- 1 less than or equal to p(X,Y) less than or equal to +1
2) A correlation of 0 (uncorrelated variables) indicates an absence of any linear (straight-line) relationship between the variables. Increasingly positive correlation indicates an increasingly strong positive linear relationship (up to 1, which indicates a perfect linear relationship). Increasingly negative correlation indicates an increasingly strong negative (inverse) linear relationship (down to -1, which indicates a perfect inverse linear relationship).

Question 18

posterior probability

Topics in Probability

Answer 18

An updated probability that reflects or comes after new information.

Question 19

combination

Topics in Probability

Answer 19

A listing in which the order of the listed items does not matter.

Question 20

permutation

Topics in Probability

Answer 20

An ordered listing.