HW 3a:

1. X ~ Normal(   100,   20)

135  100
P( X  135)  P( Z  )  P( Z  1.75)
20
From the Z-table, P(0  Z  1.75)  0.4599
So P( Z  1.75)  0.5  P(0  Z  1.75)  0.5  0.4599  0.0401

Also, using the excel function

P( X  135)  1  P( X  135)  1  NORM .DIST (135,100,20, true)
 1  0.9599  0.0401

2. X ~ Normal(   1000,   250)

800  1000 1100  1000
P(800  X  1100)  P( Z )  P(0.8  Z  0.4)
250 250
From the Z-table, P(0  Z  0.4)  0.1554 and P(0  Z  0.8)  0.2881
So
P(0.8  Z  0.4)  P(0.8  Z  0)  P(0  Z  0.4)  P(0  Z  0.8)  P(0  Z  0.4)
 0.2881  0.1554  0.4435

Also, using the excel function

P(800  X  1100)  P( X  1100)  P( X  800)
 NORM .DIST (1100,1000,250, true)  NORM .DIST (800,1000,250, true)
 0.6554  0.2119  0.4435

3. X ~ Normal(   6.3,   2.2)

P(5  X  10)  P( X  10)  P( X  5)
 NORM .DIST (10,6.3,2.2, true)  NORM .DIST (5,6.3,2.2, true)
 0.6764

P ( X  7)  1  P ( X  7 )
 1  NORM .DIST (7,6.3,2.2, true)
 0.3751

P ( X  4)
 NORM .DIST (4,6.3,2.2, true)
 0.1479
 4. X ~ Normal(   5100,   200)

P( X  5000)  1  P( X  5000)
 1  NORM .DIST (5000,5100,200, true)
 0.6915

HW 3b:

1. X ~ Normal(   82,   6)
P( X  91)  1  P( X  91)
 1  NORM .DIST (91,82,6, true)
 0.0668

2. P( X  X 0 )  P( Z  Z 0 )  0.001
So P(0  Z  Z 0 )  0.5  0.001  0.499
From the Z-table, Z0 = 3.09
X  82
Since Z 0  0 , so X 0  3.09 * 6  82  100.5
6

Also, P(Z  Z 0 )  1  0.001  0.999

From excel function NORM.S.INV(0.999) = 3.09. Follow the step above to find the X0

And Also, NORM.INV(0.999, 82, 6) = 100.5

HW 3c:

1. A variable is said to follow a Lognormal distribution if the log function of that variable is
normally distributed.
Let X1 and X2 be two variables which have Lognormal distribution and are independent
of each other.
Then LnX1 and LnX2 are normally distributed.
If Y = X1 *X2
Then LnY = Ln(X1 *X2) = LnX1 + LnX2
Since the sum of two normal distributions is still normal, then LnY is normally
distributed.
Hence, Y follow a Lognormal distribution.

2. Let Y represent the lifetime of a component part, so we need to find P (Y  4)  ?

 Let Y  e X , so X  LnY and has a normal distribution with X ~ Normal (   1,   0.5)

P(Y  4)  P( e X  4)  P( X  Ln4)  P( X  1.386)

 1  P( X  1.386)  1  NORM .DIST (1.386,1,0.5, true)
 1  0.7794  0.22

Or, in excel
P(Y  4)  1  P(Y  4)
 1  LOGNORM .DIST (4,1,0.5, true)
 0.22

HW 3d:

1.
a. Let X represent the number of earnings increase over the next 10 years. The
probability of an earnings increase in a given year is p=0.7, and the number of trials is
n=10.

X ~ Binomial ( p  0.7)
10  10!
So P( X  5)   0.7 5 (1  0.7)105  0.7 5 0.35  0.1029
5 (10  5)!5!

Or, BINOM.DIST(5,10,0.7,false) = 0.1029

b. the variance of the number of yearly increases over the 10 years is

Var ( X )  np(1  p)  10 * 0.7 * 0.3  2.1

2. After two periods, there are three possible stock prices:

S1  100 * (1  1%) * (1  1%)  102.01
S 2  100 * (1  1%) * (1  1%)  99.99
S 3  100 * (1  1%) * (1  1%)  98.01
Let X represent the number of up moves for the stock, so X ~ Binomial ( p  0.75) .
To get the price S1, there are two up moves over two periods, so the probability is
 2
P( X  2)   0.75 2 (1  0.75) 22  0.5625
 2
 To get the price S2, there are one up moves over two periods, so the probability is
 2
P( X  1)   0.751 (1  0.75) 21  0.375
1
To get the price S1, there are zero up moves over two periods, so the probability is
 2
P( X  0)   0.75 0 (1  0.75) 20  0.0625
 0

Therefore, the expected stock price is

S1 * P( X  2)  S 2 * P( X  1)  S 3 * P( X  0)
 102.01(0.5625)  99.99(0.375)  98.01(0.0625)
 101.0025

HW 3e:

a. If recovery is $0.9, the probability=0.75(0.45)=0.3375

If recovery is $0.8, the probability=0.75(0.55)=0.4125
If recovery is $0.5, the probability=0.25(0.85)=0.2125
If recovery is $0.4, the probability=0.25(0.15)=0.0375

b. E (re cov ery | scenario1)  0.45(0.9)  0.55(0.8)  $0.845

c. E (re cov ery | scenario 2)  0.85(0.5)  0.15(0.4)  $0.485
d. E (re cov ery )  0.75(0.845)  0.25(0.485)  $0.755
e. The tree diagram:

Recovery=$0.90
0.45

0.75
Expected Recovery 0.55 Recovery=$0.80
=$0.755

0.25 0.85 Recovery=$0.50

0.15
Recovery=$0.40
HM 3f:

Chapter 4:
Chapter 5: