2.2 Basic Statistics

2.2 Basic Statistics

Qustion 1

It has been observed that daily returns on spot positions of the Euro against the US Dollar are highly correlated with returns on spot holdings of the Japanese Yen against the US Dollar. This implies that:

A. When the Euro strengthens against the dollar, the yen also tends to strengthen against the dollar. The two sets of returns are not necessarily equal.
B. The two sets of returns tend to be almost equal.
C. The two sets of returns tend to be almost equal in magnitude but opposite in sign.
D. None of the above.

Answer: A
Correlation describes movement in the same direction but does not imply the same magnitude.

Correlation measures linear relationship between two random variables.

$\rho =Cov(X,Y)/\sqrt{{\sigma }_X{\sigma }_Y}$

If $\rho =0$, this does not indicate independence.

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Question 2

Roy Thomson, a global investment risk manager of FBN Bank, is assessing markets A and B using a two-factor model. In order to determine the covariance between markets A and B, Thomson developed the following factor covariance matrix for global assets:

Factor Covariance Matrix for Global Assets

	Global Equity Factor	Global Bond Factor
Global Equity Factor	0.3543	-0.0132
Global Bond Factor	-0.0132	0.3543

Suppose the factor sensitivities to the global equity factor are $0.75$ for market A and $0.45$ for market B, and the factor sensitivities to the global bond factors are $0.2$ for market A and $0.65$ for market B. The covariance between market A and Market B is closest to:

A. $-0.215$
B. $-0.113$
C. $0.113$
D. $0.215$

Answer: C
${\sigma }_E^2=0.3543$, ${\sigma }_B^2=0.0089$, $\text{Cov}(E,B)=-0.0132$

$\text{Cov}(M_A,M_B)=\text{Cov}(0.75E+0.2B,0.45E+0.65B)$

$\text{Cov}(M_A,M_B)=(0.75\times 0.45){\sigma }_E^2+(0.2\times 0.65){\sigma }_B^2+(0.75\times 0.65+0.2\times 0.45)Cov(E,B)=0.1131$

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Question 3

Which statement best describes correlations and variances in times of financial crisis?

A. There are only marginal changes in correlations and variances in times of crisis and therefore they do not need to be factored into risk management.
B. The diversification benefits decrease as correlations increase and therefore your risk level increases.
C. The diversification benefits increase as correlations decrease and therefore your risk level decreases.
D. VaR estimates using the Risk Metrics approach provide for the effects of increased correlations during periods of crisis and therefore the effects are factored into current positions.

Answer: B
During crisis situations the correlation between global markets increases as suggested by empirical evidence. The implication of this increased correlation is that the maximum amount to be lost for a given probability over a given time period increases. Therefore, diversification benefits decrease when correlations rise and therefore the risk level increases.

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Question 4

PE2018Q69 / PE2019Q69 / PE2020Q69 / PE2021Q69 / PE2022Q69
The recent performance of Prudent Fund, with USD $50$ million in assets, has been weak and the institutional sales group is recommending that it be merged with Aggressive Fund, a USD $200$ million fund. The returns on Prudent Fund are normally distributed with a mean of $3\%$ and a standard deviation of $7\%$ and the returns on Aggressive Fund are normally distributed with a mean of $7\%$ and a standard deviation of $15\%$. Senior management has asked you to estimate the likelihood that returns on the combined portfolio will exceed $26\%$. Assuming the returns on the two funds are independent, your estimate for the probability that the returns on the combined fund will exceed $26\%$ is closest to:

A. $1.0\%$
B. $2.5\%$
C. $5.0\%$
D. $10.0\%$

Answer: C
Learning Objective:

• Calculate the probability of an event for a discrete probability function.
• Compute the variance of a weighted sum of two random variables.
• Explain how the iid property is helpful in computing the mean and variance of a sum of iid random variables.

Since these are independent normally distributed random variables(${\rho }_{1,2}=0$)

The combined expected mean return is:
$\mu ={\omega }_1{\mu }_1+{\omega }_2{\mu }_2=0.2\times 3\%+0.8\times 7\%=6.2\%$

The combined volatility is:
$\sigma =\sqrt{{\omega }_1^2{\sigma }_1^2+{\omega }_2^2{\sigma }_2^2}=\sqrt{0.2^2\times 0.07^2+0.8^2\times 0.15^2}=12.1\%$

The appropriate Z-statistic is:
$P(x>26\%)=P(\frac{x-\mu }{\sigma }>1.64)=P(z>1.64)=5.0\%$

For normal distribution:
$68\%$ confidence interval is $\mu \pm \sigma$
$90\%$ confidence interval is $\mu \pm 1.65\sigma$
$95\%$ confidence interval is $\mu \pm 1.96\sigma$
$99\%$ confidence interval is $\mu \pm 2.58\sigma$

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Question 5

The returns of the stocks over the last year in a large portfolio follow a distribution that is approximately normal. An unethical analyst removes some of the very worst performing stocks and produces reports based on the altered portfolio returns. Which of the following statements about the returns of the altered portfolio is (are) correct?

I The distribution of returns of the altered portfolio is likely to be positively skewed.
II The distribution of returns of the altered portfolio is likely to be negatively skewed.
III The mean return is likely to be lower compared to the original portfolio.
IV The median return is likely to be higher compared to the original portfolio.

A. I only
B. II and III
C. II and IV
D. I and IV

Answer: D
The distribution of returns is likely to be positively skewed, since the extreme values on the extreme left side of the distribution have been removed. And, removing some of the lowest values will increase the mean and median.

Postive(right) skewness: Mode<Median<Mean; Right fat tall; Frequent small losses, a few extreme gains
Negative(left) skewness: Mode>Median>Mean; Left fat tall; Frequent small gains, a few extreme losses

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Question 6

Which of the following statements concerning probability distributions is (are) correct?

I The variance of a standard normal distribution is $1$.
II Risk analysts would not be able to assume a distribution is normal which kurtosis is equal to $3$.

A. I only
B. II only
C. Both I and II
D. Neither I nor II

Answer: C
A standard normal distribution has a mean of 0 and a variance of 1.
One of the properties of a standard normal distribution is that kurtosis is equal to 3.
正态分布来说峰度等于3, 但是峰度等于3不一定是正态分布

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Question 7

Let X and Y be two random variables representing the annual returns of two different portfolios. If $E[X]=3$, $E[Y]=4$ and $E[XY]=11$, then what is $Cov[X,Y]$?

A. $-1$
B. $0$
C. $11$
D. $12$

Answer: A
$Cov(X,Y)=E(XY)-E(X)E(Y)=11-3\times 4=-1$

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Question 8

An economic analyst as calculated the probabilities of three possible states for the economy next year: growth ,normal ,and recession. A bank analyst has estimated the possible returns on two stocks, A and B, in each of the three scenarios shown in the following table:

State	Probability	Return of Stock A	Return of Stock B
Growth	0.20	0.30	0.20
Normal	0.60	0.10	0.10
Recession	0.20	-0.20	-0.10

Given that the standard deviation of the estimated returns on stocks A and B are $16.0\%$ and $9.8\%$, respectively, what is the covariance of the estimated returns on stocks A and B?

A. $-0.0187$
B. $-0.0156$
C. $0.0156$
D. $0.0178$

Answer: C
$E_A=0.2\times 0.3+0.6\times 0.1+0.2\times -0.2=0.08$
$E_B=0.2\times 0.2+0.6\times 0.1+0.2\times -0.1=0.08$
$Cov(A,B)=E[(A-E_A)(B-E_B)]=0.2\times (0.08-0.3)(0.08-0.2)+0.6\times (0.08-0.1)(0.08-0.1)+0.2\times (0.08+0.2)(0.08+0.1)=0.01552$

或者用计算器直接计算出$\rho$， 再使用${\rho }_{X,Y}=\frac{Cov(X,Y)}{{\sigma }_X{\sigma }_Y}$

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Question 9

An analyst gathered the following information about the return distributions for two portfolios during the same time period:

Portfolio	Skewness	Kurtosis
A	-1.6	1.9
B	0.8	3.2

The analyst states that the distribution for Portfolio A is more peaked than a normal distribution and that the distribution for Portfolio B has a long tail on the left side of the distribution. Which of the following is correct?

A. The analyst’s assessment is correct.
B. The analyst’s assessment is correct for Portfolio A and incorrect for portfolio B.
C. The analyst’s assessment is incorrect for Portfolio A but is correct for portfolio B.
D. The analyst is incorrect in his assessment for both portfolios.

Answer: D
The analyst’s statement is incorrect in reference to either portfolio. Portfolio A has a kurtosis of less than $3$, indicating that it is less peaked than a normal distribution (platykurtic). Portfolio B is positively skewed (long tail on the right side of the distribution).

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Question 10

Which of the following exhibit positively distributions?

I. Normal Distribution
II. Lognormal Distribution
III. The Returns of Being Short a Put Option
IV. The Returns of Being Long a Call Option

A. Il only
B. Ill only
C. Il and IV only
D. I, IlI, and IV only

Answer: C
A lognormal distribution is positively skewed because it cannot contain negative values. The returns on a long call position cannot be more negative than the premium paid for the option but has unlimited potential positive value, so it will also be positively skewed.

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Question 11

Which type of distribution produces the lowest probability for a variable to exceed a specified extreme value $X$ which is greater than the mean assuming the distributions all have the same mean and variance?

A. A leptokurtic distribution with a kurtosis of $4$
B. A leptokurtic distribution with a kurtosis of $8$
C. A normal distribution
D. A platykurtic distribution

Answer: D
A. Incorrect. A leptokurtic distribution has fatter tails than the normal distribution. The kurtosis indicates the level of fatness in the tails, the higher the kurtosis, the fatter the tails. Therefore, the probability of exceeding a specified extreme value will be higher.
B. Incorrect. Since answer A has a lower kurtosis, a distribution with a kurtosis of $8$ will necessarily produce a larger probability in the tails.
C. Incorrect. By definition, a normal distribution has thinner tails than a leptokurtic distribution and larger tails than a platykurtic distribution.
D. Correct. By definition, a platykurtic distribution has thinner tails than both the normal distribution and any leptokurtic distribution. Therefore, for an extreme value $X$, the lowest probability of exceeding it will be found in the distribution with the thinner tails.

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Question 12

An analyst is concerned with the symmetry and peakedness of a distribution of returns over a period of time for a company she is examining. She does some calculations and finds that the median return is $4.2\%$, the mean return is $3.7\%$, and the mode return is $4.8\%$. She also finds that the measure of kurtosis is $2$. Based on this information, the correct characterization of the distribution of returns over time is:

 Skewness Kurtosis
A. Positive  Leptokurtic
B. Positive  Platykurtic
C. Negative Platykurtic
D. Negative  Leptokurtic

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Question 13

In looking at the frequency distribution of weekly crude oil price changes between 1984 and 2008, an analyst notices that the frequency distribution has a surprisingly large number of observations for extremely large positive price changes and a smaller number, but still a surprising one of observations for extremely large negative price changes. The analyst provides you with the following statistical measures. Which measures would help you identify these characteristics of the frequency distribution?

I. Serial correlation of weekly price chances
II. Variance of weekly price changes
III. Skewness of weekly price changes
IV. Kurtosis of weekly price changes

A. I, II, III and IV
B. Il only
C. III and IV only
D. I, IlI and IV only

Answer: C
The question considers a skewed leptokurtic distribution. To measure the magnitude of these skewed tails, the analyst needs to consider both the skewness and kurtosis.

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Question 14

Assume that a random variable X follows a normal distribution, let $Y=a+bX$, where $a$ and $a$ are both constant values and $b$ is negative, which of the following statements is correct?

A. The mean of $Y$ is identical to the mean of $X$.
B. The location shift of $a$ has no effect on the variance of $Y$.
C. The skewness of $Y$ is identical to the skewness of $X$.
D. The kurtosis is affected by decreasing linear transformations.

Answer: B
The mean of Y is $E[Y]=a+bE[X]$
The variance of Y is $V[Y]=b^{2}V[X]$ or $b^2{\sigma }^2$
If $b>0$, the skewness and kurtosis of $Y$ are identical to the skewness and kurtosis of $X$.
If $b<0$, (and thus $Y=a+bX$, is a decreasing transformation), then the skewness has the same magnitude but the opposite sign.