Chapter 4 Flashcards
What is empirical probability based on?
It is based on historical data
What is priori (classical) probability based on?
It is based on logical reasoning and analysis
What is subjective probability based on?
It is based on drawing on personal judgment
What does covariance and correlation coefficients indicate?
It indicates the relationship between securities’ rates of return
What does covariance measure?
The extent to which 2 variables move together linearly
What does correlation coefficient measure?
Measures the strength of linear association between 2 variables
What is a frequency distribution?
It is a table summarising , into a small number of intervals, the possible values and frequencies of a variable.
What is a histogram?
It is the graphical equivalent of a frequency distribution.
What is the advantage of a histogram?
It can be quickly seen where the most observations lie
What is the mean?
It is the most frequently used measure of the middle of data. It is the sum of all the observations divided by the number of observations.
What is dispersion?
It is the variability around the mean.
What is dispersion in investment terms?
The dispersion around the mean addresses the risk of the investment.
What is range?
Range is the difference between the max and min values in a set of data
What does the mean absolute deviation (MAD) do?
It measures the absolute deviations around the mean.
Why are absolute deviations used in mean absolute deviations (MAD)
To avoid the problem of negative deviations cancelling out positive deviations.
How does variance and standard deviation address the issue of negative deviations cancelling out positive deviations?
They address this issue by squaring deviations from the mean.
True or false. The mean absolute deviation will always be greater than the standard deviation.
False. The mean absolute deviation will always be equal or less than the standard deviation. Standard deviation gives more weight to large deviations.
When is a distribution symmetric (normal) ?
When the distribution is identical to the left and right
What does a return distribution with a negative (left) skew indicate?
Numerous small gains and a few large losses
What does a return distribution with a positive (right) skew indicate?
Many small losses and a few substantial gains.
Which skewness do investors prefer?
Many small losses and a few substantial gains
How are conclusions drawn with inference statistics?
It is drawn based on analysis on a sample of data
What does the term mutually exclusive mean?
Only one event can occur at a time
What are the 3 methods used to estimate probabilities?
Empirical probability - estimated as a relative frequency of occurrence based on historical data
Priori/classical probability - deduced by logical reasoning and analysis rather than on observation or personal judgement
Subjective probability - estimated by drawing on subjective or personal judgement.
What is unconditional/marginal probability?
It is the single probability that an event will occur.
What is conditional probability?
The probability that an event will occur, given that 1+ other events have occurred.
What does covariances and correlation coefficients indicate?
It indicates the relationship between securities’ rates of return.
What does a positive covariance indicate?
It indicates that on average the rates of return of the 2 securities move in the same direction.
What does a correlation of +1, 0, and -1 indicate?
+1: indicates an exact positive linear relationship between the 2 variables
0: indicates that there is no linear relationship between the 2 variables
-1: indicates that although variables move in perfect unison they move in opposite directions
