READING 4 PROBABILITY TREES AND CONDITIONAL EXPECTATIONS

Question 1

The …. of a random variable is the weighted average of the possible outcomes for the variable

Answer 1

Expected value

Question 2

The probability distribution of earnings per share (EPS) for Ron’s Stores is given in the following figure. Calculate the expected EPS.

Probability EPS
10% 1.80
20% 1.60
40% 1.20
30% 1.00

Answer 2

E(EPS)= 0.10(1.80) + 0.20(1.60) + 0.40(1.20) + 0.30(1.00) = 1.28

Question 3

Measure the dispersion of a random variable around its expected value, sometimes referred to as the volatility of a random variable

Answer 3

Standard deviation and Variance

Question 4

(from a probability model) can be calculated as the probability-weighted sum of the squared deviations from the mean (or expected value)

Answer 4

Variance

Question 5

The positive square root of the variance

Answer 5

Standard deviation

Question 6

Expected values or expected returns can be calculated using

Answer 6

Conditional probabilities

Question 7

Is used to show the probabilities of various outcomes

Answer 7

Probability tree

Question 8

True or false

Conditional expected values are contingent on the outcome of some other event

Answer 8

true

Question 9

Used to update a given set of prior probabilities for a given event in response to the arrival of new information

Answer 9

Bayes formula