UNIVERSITY OF THE WESTERN CAPE

SEMESTER TEST 1 – SOLUTIONS MEMO

6 April 2024

LECTURER: Mr C. Priem

MODULE NAME: Introductory Statistics for Financial Analysis

MODULE CODE: FIN213

DURATION: 90 MINUTES MARKS: 50

GENERAL INSTRUCTIONS:

This examination paper consists of 9 printed pages (including cover sheet); please ensure that you have
all of them.

Please ensure that your Student Number is clearly printed on the examination answer booklet/s.

Also ensure that your student number is correctly captured on the multiple choice answer sheet.

You may not have any books, writing paper, notes, manuscripts, electronic media (cellphones, smart
devices, laptops, etc.) in your possession, unless otherwise stipulated in this examination question paper.

Calculators may be used.

Please ensure that your answer booklet, multiple choice answer sheet and question paper are collected
by an invigilator at the end of the examination session.

Examination answer booklets must be intact when collected by the invigilator. No stapled, paper clipped
or glued booklets will be accepted.

Please answer all questions and it is in your interest to write in a legible manner.

In Section B, show the important workings/inputs/calculations.

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SECTION A [15 Marks]

1. Published ratings on stocks ranging from 1 (strong sell) to 5 (strong buy) are examples of which
measurement scale?

A. Ordinal
B. Continuous
C. Nominal
D. None of the above

2. An equity analyst gathers total returns for three country equity indexes over the past four years. The
data are presented below.

Each individual row of data in the table can be best characterized as:

A. panel data
B. time-series data
C. cross-sectional data
D. None of the above

3. In a frequency distribution, the absolute frequency measure:

A. represents the percentages of each unique value of the variable.

B. represents the actual number of observations counted for each unique value of the variable.
C. allows for comparisons between datasets with different numbers of total observations.
D. represents the range

4. Which of the following is a potential problem with interpreting a correlation coefficient?

A. Outliers
B. Spurious correlation
C. Both outliers and spurious correlation
D. None of the above

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5. An analyst examined a cross-section of annual returns for 252 stocks and calculated
the following statistics:

The coefficient of variation is closest to:

A. 0.02
B. 0.42
C. 2.41
D. 3.81

6. Which probability estimate most likely varies greatly between people?

A. An a priori probability
B. An empirical probability
C. A subjective probability
D. None of the above

7. The probability of an event given that another event has occurred is a:

A. joint probability
B. marginal probability
C. conditional probability
D. total probability

8. Which of the following is a property of two dependent events?

A. The two events must occur simultaneously

B. The probability of one event influences the probability of the other event
C. The probability of the two events occurring is the product of each event’s probability
D. None of the above

9. Which of the following statements is most accurate? If the covariance of returns between two assets is
0.0023, then:

A. the assets’ risk is near zero

B. the asset returns are unrelated
C. the asset returns have a positive relationship
D. None of the above

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10. From an approved list of 25 funds, a portfolio manager wants to rank 4 mutual funds from most
recommended to least recommended. Which formula is most appropriate to calculate the number of
possible ways the funds could be ranked?

A. Permutation formula
B. Multinomial formula
C. Combination formula
D. None of the above

11. The value of the cumulative distribution function F(x), where x is a particular outcome, for a discrete
uniform distribution:

A. sums to 1
B. lies between 0 and 1
C. decreases as x increases
D. None of the above

12. In a discrete uniform distribution with 20 potential outcomes of integers 1 to 20, the probability that
X is greater than or equal to 3 but less than 6, P(3 ≤ X < 6), is:

A. 0.10
B. 0.15
C. 0.20
D. 0.25

13. Which of the following is characteristic of the normal distribution?

A. Asymmetry
B. Kurtosis of 3
C. Definitive limits or boundaries
D. None of the above

14. Which of the following events can be represented as a Bernoulli trial?

A. The flip of a coin

B. The closing price of a stock
C. The picking of a random integer between 1 and 10
D. None of the above

15. Which parameter equals zero in a normal distribution?

A. Kurtosis
B. Skewness
C. Standard deviation
D. Variance

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SECTION B [35 Marks]

Question 1 (7)

A fund had the following experience over the past 6 years:

Year Return
1 4.5%
2 6.0%
3 1.5%
4 -2.0%
5 0.0%
6 4.5%

Calculate the following:

1.1. The geometric mean (3 marks)

1.2. The sample variance (4 marks)

ANSWER

Return less
Squared
Year Return GM Mean
1 4.5% 1.0450 2.083333% 0.043403%
2 6.0% 1.0600 3.583333% 0.128403%
3 1.5% 1.0150 -0.916667% 0.008403%
4 -2.0% 0.9800 -4.416667% 0.195069%
5 0.0% 1.0000 -2.416667% 0.058403%
6 4.5% 1.0450 2.083333% 0.043403%
14.5% 1.1514 Sum of products 0.477083% Sum
Mean 2.42% 1.0238 6th Root 0.095417% Variance
GM 2.38% 0.0238 GM
Variance 0.000954167

Question 2 (8)

The table below reflects holding period % returns for a sample portfolio P and a sample index I.

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Calculate the following:

2.1. The standard deviation for portfolio P. (3 marks)

2.2. The standard deviation for index I. (3 marks)

2.3. The correlation coefficient for portfolio P and index I. (2 marks)

ANSWER
Standard Deviation
P less Mean P squared I less Mean 1 squared
0.5000% 0.0025% -0.5615% 0.0032%
-1.0000% 0.0100% -1.7248% 0.0297%
-0.9000% 0.0081% -1.4237% 0.0203%
1.6000% 0.0256% 4.5433% 0.2064%
-0.2000% 0.0004% -0.8333% 0.0069%
0.0466% Sum 0.2665% Sum
0.01% 0.01% Sample variance 0.07% 0.07% Sample variance
1.08% 1.08% Standard deviation 2.58% 2.58% Standard deviation

Correlation Coefficient
P less Mean I less Mean Product P, I )
0.5000% -0.5615% -0.0028%
-1.0000% -1.7248% 0.0172%
-0.9000% -1.4237% 0.0128%
1.6000% 4.5433% 0.0727%
-0.2000% -0.8333% 0.0017%
0.1016% Sum
0.0254% 0.0254% Covariance
0.0279% Product of SD P and I
0.9118 0.9118 Correlation Coefficient

Question 3 (4)

The following exhibit shows the annual MSCI World Index total returns for a 10-year period.

Calculate the mean absolute deviation of the MSCI World Index total returns for Year 6 to Year 10.

ANSWER
Column 1: Sum annual returns and divide by n to find the arithmetic mean of 16.40%.
Column 2: Calculate the absolute value of the difference between each year’s return and the mean from

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Column 1. Sum the results and divide by n to find the MAD.

These calculations are shown in the following exhibit:

Question 4 (5)

A stock is priced at $100.00 and follows a one-period binomial process with an up move that equals 5%
and a down move that equals 3%. 1 million Bernoulli trials are conducted and the average terminal stock
price is $104.00.

Given the above information, calculate the probability of an up move (p).

ANSWER
0.875 (87.5%).
The probability of an up move (p) can be found by solving the equation:
(p)uS + (1 – p)dS = (p)105 + (1 – p)97 = 104
p105 - p97 = 104 - 7
8p = 7
p = 7 / 8 = 0.875 (87.5%)

Question 5 (6)

You have developed a set of criteria for evaluating distressed credits. Companies that do not receive a
passing score are classed as likely to go bankrupt within 12 months. You gathered the following
information when validating the criteria:
• Forty percent of the companies to which the test is administered will go bankrupt within 12 months:
P(nonsurvivor) = 0.40.
• Fifty-five percent of the companies to which the test is administered pass it: P(pass test) = 0.55.
• The probability that a company will pass the test given that it will subsequently survive 12 months, is
0.85: P(pass test | survivor) = 0.85.

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5.1. What is P(pass test | nonsurvivor)? (4 marks)

5.2. Using Bayes’ formula, calculate the probability that a company is a survivor, given that it passes the
test; that is, calculate P(survivor | pass test). (2 marks)

ANSWER
5.1. We can set up the equation using the total probability rule:
P(pass test) = P(pass test | survivor)P(survivor) + P(pass test | nonsurvivor)P(nonsurvivor)
We know that P(survivor) = 1 – P(nonsurvivor) = 1 – 0.40 = 0.60
Therefore, P(pass test) = 0.55 = 0.85(0.60) + P(pass test | nonsurvivor)(0.40)
Thus P(pass test | nonsurvivor) = [0.55 – 0.85(0.60)]/0.40 = 0.10

5.2. P(survivor | pass test) = [P(pass test | survivor) / P(pass test)] x P(survivor)
= (0:85 / 0:55)0:60 = 0:927273

The information that a company passes the test causes you to update your probability that it is a survivor
from 0.60 to approximately 0.927.

Question 6 (5)

A portfolio has an expected mean return of 8 percent and standard deviation of 14 percent. Using the
table above (Exhibit 1), calculate the probability that its return falls between 8 and 11 percent.

ANSWER
P(8% ≤ Portfolio return ≤ 11%) = N(Z corresponding to 11%) – N(Z corresponding to 8%).
For the first term, Z = (11% – 8%) / 14% = 0.21 approximately, and using the table of cumulative
normal distribution above, N(0.21) = 0.5832.
To get the second term immediately, note that 8% is the mean, and for the normal distribution 50% of
the probability lies on either side of the mean.
Therefore, N(Z corresponding to 8%) must equal 50%.
So P(8% ≤ Portfolio return ≤ 11%) = 0.5832 – 0.50 = 0.0832 or approximately 8.3 percent.

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 Useful Formulae and Equations

Geometric Mean

NOTE: The value 1 must be deducted from the result of the formula (Result of formula - 1)

Mean Absolute Deviation

Sample Variance

Standard Deviation

Coefficient of Variation

Covariance

Correlation Coefficient (r)

Multinomial Formula

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Combination Formula

Permutation Formula

Probability of x successes in n trials

Probability Stated as Odds given a probability P(E)

Odds for E = P(E) / [1 - P(E)]
Odds against E = [1 - P(E)] / P(E)

Conditional Probability

Multiplication Rule for Probability

Addition Rule for Probabilities

Multiplication Rule for Independent Events

Expected Value

Variance

Total Probability Rule for Expected Value

Bayes’ Formula

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Safety-first ratio

Continuously compounded return

Normally Distributed Population with Known Variance

The z-Alternative (Large Sample, Population Variance Unknown)

t-Distribution (Population Variance Unknown)

Standard error (Known Population Standard Deviation)

Standard error (Unknown Population Standard Deviation)

A 100(1 − α)% confidence interval for a parameter

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