FN 211 Self test 4: Data summary, confidence intervals, and hypothesis testing

Conceptual questions (No solution, self study and research)

1. What is the difference between the mean and the median?

2. What are the possible ways to resolve outlier problems when computing the mean?

Describe and provide examples.

3. How do you calculate the median? Can there be two medians? What if two medians are

noted and they are the same number?

4. Can you write formulas for expected value (weighted mean) and geometric mean?

5. What is compounded annual growth rate (CAGR)? How is it often used in finance? Provide

example.

6. There are several different types of variability. Variance and standard deviation are the

most important. How do they differ? Can you write formula for them?

7. What is the difference between population statistics and sample statistics?

8. What is a confidence interval?

9. Describe and provide numerical example how you can create confidence intervals with a)

normal distribution assumption, and b) by bootstrapping the selected sample.

10. Which has a larger range of values, 95% or 99% confidence intervals? Why?

11. How does the alpha level relate to a Type I Error?

12. How do you transform a normally distributed random variable to a standard normal random

variable? Why is this transformation useful?

13. What are the conventional levels of significance set by most researchers? What do these

values mean (i.e., alpha values of .05 and .01)?

14. Describe the steps in conducting a hypothesis test. Provide an example.

15. What is the difference between covariance and correlation? Write out their formula.

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Understanding mathematical notations

1. Let
x i ∈ {1,2,3,5} Compute ∑i x i for
∀ xi

For questions 2-6 use this dataset

z x y
1 3 4
2 -1 -2
3 2 -2
4 4 2
5 5 3
6 -3 -5

2. Evaluate
∑i ( xi − x̄ )

3. Evaluate
∑i ( xi − x̄ )
2

4. Evaluate
∑i ( xi − x̄ )( y i − ȳ )

5. Evaluate
∑i ( xi − x̄ )⋅∑i ( y i− ȳ )

6. The distributive rule of summation is

N N N
∑ ( xi + zi )= ∑ ( x i )+ ∑ ( zi )
i=1 i=1 i=1

Can you verify this using data given?

N
7. Equation Σ i=1 a=Na is the first constant rule of summation. Can you evaluate expression?
N
∑ ( 2 x j−5 ) 2
i=1

2
 N N
∑ axi =a ∑ x i
8. The second constant rule of summation is i=1 i=1 . Can you reduce the following
N
∑ 6 yx i
expression i=1 ?

Problems

9. The next table provide annual portfolio values and returns for three funds, Onion, Garlic, and
Lime.

Portfolio Portfolio Portfolio

Year Onion Return Garlic Return Lime Return
0 100 100.0 100
1 50 -50% 115.0 15% 107 7%
2 100 100% 132.3 15% 111 4%

Compute the compounded annual growth rate (CAGR) of portfolio or Geometric mean (GM) and
arithmetic mean (AM) of each fund. Analyze results.

10. Compute expected sales growth and SD. of sales growth from data table

State Probability Sales Growth

1 0.15 5%
2 0.55 7%
3 0.3 9%

11. Evaluate the covariance and correlation between money supply and inflation. What do the
numbers mean?

Money supply Inflation

Country X Y
Australia 0.1166 0.0676
Canada 0.0915 0.0519
NZ 0.106 0.0815
Swiss 0.0575 0.0339
UK 0.1258 0.0758
US 0.0634 0.0509
Mean 0.0935 0.0603
SD (small sample) 0.0281 0.0179

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12. From Neil Salkind Ch. 10

Flu cases this past flu season in ABC school (n=500) were 15 per week. For the entire city, the weekly
average was 16 and SD was 15.1. Are the kids in ABC school as sick as other kids? Assume 95%
confidence interval (alpha of 5%)

13. From Quantitative investment analysis Ch 7. (CFA publication)

Fashion Designs, a supplier of clothing is concerned about a possible slow down in payments of
customers. The accounting manager reports that mean number of collection period is 49 days
compared to industry average of 45. The industry SD of collection period is 8. There are 30 firms in
the industry.

13.1 Formulate a null and alternative hypothesis to determine whether evidence supports the
suspected conditions.

13.2 Conduct and test and conclude

Solutions

Understanding mathematical notations

1. Let
x i ∈ {1,2,3,5} Compute ∑i x i for
∀ xi

Ans:
∑i x i = 1+2+3+4+5

For questions 2-6 use this dataset

z x y
1 3 4
2 -1 -2
3 2 -2
4 4 2
5 5 3
6 -3 -5

4
2. Evaluate
∑i ( xi − x̄ )
Ans:

z x y x-xbar
1 3 4 1.33
2 -1 -2 -2.67
3 2 -2 0.33
4 4 2 2.33
5 5 3 3.33
6 -3 -5 -4.67

Xbar = 1.67 (sum of x dividend by 6)

Sum of 4th column is 1.33-2.67+.033+2.33+3.33-4.67 = 0

3. Evaluate
∑i ( xi − x̄ )
2

Ans: 47.33 (From table)

(x-xbar)(y-
z x y x-xbar (x-xbar)^2 y-ybar
ybar)
1 3 4 1.33 1.78 4 5.33
2 -1 -2 -2.67 7.11 -2 5.33
3 2 -2 0.33 0.11 -2 -0.67
4 4 2 2.33 5.44 2 4.67
5 5 3 3.33 11.11 3 10.00
6 -3 -5 -4.67 21.78 -5 23.33
Sum 0.00 47.33 0.00 48.00

4. Evaluate
∑i ( xi − x̄ )( y i − ȳ )

Ans: 48 (From table)

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5. Evaluate
∑i ( xi − x̄ )⋅∑i ( y i− ȳ )
Ans: 0 * 0 = 0

6. The distributive rule of summation is

N N N
∑ ( xi + zi )= ∑ ( xi )+ ∑ ( zi )
i=1 i=1 i=1

Can you verify this using data given?

Ans : Both methods should yield 21 + 10 = 31.

N
7. Equation Σ i=1 a=Na is the first constant rule of summation. Can you evaluate expression?
N
∑ ( 2 x j−5 )2
i=1

2
N ( 2 x j−5 )
Ans:

N N
∑ axi =a ∑ x i
8. The second constant rule of summation is i=1 i=1 . Can you reduce the following
N
∑ 6 yx i
expression i=1 ?

Ans:
N N
∑ 6 yx i =6 y ∑ xi
i=1 i=1

Problems

9. The next table provide annual portfolio values and returns for three funds, Onion, Garlic, and
Lime.

Portfolio Portfolio Portfolio

Year Onion Return Garlic Return Lime Return
0 100 100.0 100
1 50 -50% 115.0 15% 107 7%

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 2 100 100% 132.3 15% 111 4%

Compute the compounded annual growth rate (CAGR) of portfolio or Geometric mean (GM) and
arithmetic mean (AM) of each fund. Analyze results.

Ans:

Portfolio Portfolio
Year Portfolio Onion Return Garlic Return Lime Return
0 100 100.0 100
1 50 -50% 115.0 15% 107 7%
2 100 100% 132.3 15% 111 4%

AM 25% 15% 5.37%

GM 0% 15% 5.36%

Onion

AM = [(-50%) + 100%]/2 = 25%

GM = [(1-0.5)(1+1)]1/2 – 1 = (0.5x2)1/2 - 1 = 0

You can see that AM shows Onion performing 25% whereas GM shows Onion have not generated
any returns ie. GM =0%. The latter makes more sense as you can see that Onion’s portfolio value
end of year 2 remains unchanged at 100.

Similarly, we can compute the rest for Garlic and Lime.

Notice that AM and GM are vastly different when returns (the random variable we wish to analyze)
have large swings, AM = GM, when each period return is constant, and AM and GM differs slightly
when variations in returns (or any r.v.) is small. Care must be taken when we use AM or GM in
finance work. When estimating growth data is highly volatile, finance people tend to use GM.

10. Compute expected sales growth and SD. of sales growth from data table

State Probability Sales Growth

1 0.15 5%
2 0.55 7%
3 0.3 9%

Ans:

Expected sales growth

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= 0.15(5%) + 0.55(7%) + 0.3(9%) = 7.3%

SD sales growth

n
σ 2 ( X ) =∑ [ X i −E ( X ) ] P ( X i)
2

i=1

= 0.15(5%-7.3%)2 + 0.55(7%-7.3%)2 +0.3(9%-7.3%)2

= 0.000171

SD is 0.0131 or approx. 1.31%

11. Evaluate the covariance and correlation between money supply and inflation. What do the
numbers mean?

Money supply Inflation

Country X Y
Australia 0.1166 0.0676
Canada 0.0915 0.0519
NZ 0.106 0.0815
Swiss 0.0575 0.0339
UK 0.1258 0.0758
US 0.0634 0.0509
Mean 0.0935 0.0603
SD (small sample) 0.0281 0.0179

Ans:

Money supply Inflation

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 Country X Y x-xbar y-ybar (x-xbar)(y-ybar)
Australia 0.1166 0.0676 0.0231 0.0073 0.000169644
Canada 0.0915 0.0519 -0.0020 -0.0084 0.00001645
NZ 0.106 0.0815 0.0125 0.0212 0.000266124
Swiss 0.0575 0.0339 -0.0360 -0.0264 0.000948321
UK 0.1258 0.0758 0.0323 0.0155 0.000502244
US 0.0634 0.0509 -0.0301 -0.0094 0.000281624
Mean 0.0935 0.0603 Sum 0.002184413
SD 0.0281 0.01789 Covar = Sum/5 0.000436883

Degrees of freedom: N-1: 6-1 =5 in this example.

Correlation = 0.00044/[(0.0281)(0.0179)] = 0.87

Money supply and inflation exhibit a positive covariance of 0.00044 suggesting that they move
together. More succinctly, when the covariance is rescaled to correlation, the we can see that the
extent of the linear relationship between the two variables are very strong at 0.87.

12. From Neil Salkind Ch. 10

Flu cases this past flu season in ABC school (n=500) were 15 per week. For the entire city, the weekly
average was 16 and SD was 15.1. Are the kids in ABC school as sick as other kids? Assume 95%
confidence interval (alpha of 5%)

Ans: Null is No of Kids in ABC school getting sick has same average as city mean average

Alternative is No of kids in ABC school getting sick is different from city mean average

SE = 15.1/sqrt(500) = 0.675

Z value is (15-16)/0.675 = -1.481

With 95% CI, this Z value is within the accepted mean interval. We would need value of Z to be
outside absolute value of +/-1.96 or approx. +/-2.00 to conclude that the school sample is different.
Thus, we do not have evidence to reject the null.

13. From Quantitative investment analysis Ch 7. (CFA publication)

Fashion Designs, a supplier of clothing is concerned about a possible slow down in payments of
customers. The accounting manager reports that mean number of collection period is 49 days
compared to industry average of 45. The industry SD of collection period is 8. There are 30 firms in
the industry.

13.1 Formulate a null and alternative hypothesis to determine whether evidence supports the
suspected conditions.

Let  = mean collection period

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H0:   45

H1:  > 45

13.2 Conduct and test and conclude

SE = 8/sqrt(30) = 1.46

Z test shows (49-45)/1.46 = 2.73

This z value shows that p-value associated with it is 1-0.99 or 0.01 indicating that Fashion design’s
collection period is significantly above industry average.

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