Topic 17 - Distributions Test ID: 8450933

Question #1 of 32 Question ID: 438802

Standardizing a normally distributed random variable requires the:

✓ A) mean and the standard deviation.

✗ B) variance and kurtosis.
✗ C) natural logarithm of X.
✗ D) mean, variance and skewness.

Explanation

All that is necessary is to know the mean and the variance. Subtracting the mean from the random variable and dividing the
difference by the standard deviation standardizes the variable.

Question #2 of 32 Question ID: 438818

Which of the following statements is true regarding the mixture of distributions for risk modeling?

I. Distributions should never be combined.

II. It may be helpful to create a new distribution if the underlying data you are working with does not currently fit a pre-determined
distribution.

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

Explanation

Distributions can be combined to create unique probability density functions. It may be helpful to create a new distribution if the
underlying data you are working with does not currently fit a pre-determined distribution. In this case, a newly created distribution
may assist with explaining the relevant data set.

Question #3 of 32 Question ID: 438789

Which of the following statements about a normal distribution is least accurate?

✓ A) A normal distribution has excess kurtosis of three.

✗ B) The mean, median, and mode are equal.
✗ C) Approximately 68% of the observations lie within +/- 1 standard deviation of the mean.
✗ D) The mean and variance completely define a normal distribution.

Explanation

Even though normal curves have different sizes, they all have identical shape characteristics. The kurtosis for all normal

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distributions is three; an excess kurtosis of three would indicate a leptokurtic distribution. The other choices are true.

Question #4 of 32 Question ID: 438816

The central limit theorem states that, for any distribution, as n gets larger, the sampling distribution:

✗ A) becomes smaller.
✗ B) approaches the mean.
✗ C) becomes larger.
✓ D) approaches a normal distribution.

Explanation

As n gets larger, the variance of the distribution of sample means is reduced, and the distribution of sample means approximates
a normal distribution.

Question #5 of 32 Question ID: 438804

Given the probabilities N(-0.5) = 0.3085, N(0.75) = 0.7734, and N(1.50) = 0.9332 from a z-table, the probability of 0.2266
corresponds to:

✗ A) N(0.50).
✓ B) N(-0.75).
✗ C) N(0.25).
✗ D) N(-0.25).

Explanation

This problem is checking your knowledge of a normal distribution and gives you more information than you need to answer the
question. The area of a normal distribution is 1, with two symmetric halves that equal 0.5 each. N(0.75) means that the area to
the left of 0.75 on the positive portion of the curve is 0.7734. This means that the area to the right of 0.75 is (1.0 - 0.7734) =
0.2266. Since the halves of a normal distribution are symmetrical, that means the area to the left of (-0.75) is also 0.2266.

Question #6 of 32 Question ID: 438788

An analyst has determined that the probability that the S&P 500 index will increase on any given day is 0.60 and the probability
that it will decrease is 0.40. The expected value and variance of the number of up days in a 5-day period are closest to:

✗ A) 2.0 and 2.1.

✓ B) 3.0 and 1.2.
✗ C) 3.0 and 1.1.
✗ D) 2.0 and 0.5.

Explanation

E(X)=np=5(0.60)=3.0. Var(X)=np(1-p)=5(0.60)(0.40)=1.2.

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Question #7 of 32 Question ID: 438790

A normal distribution can be completely described by its:

✗ A) standard deviation.
✗ B) skewness and kurtosis.

✗ C) mean and mode.

✓ D) mean and variance.

Explanation

The normal distribution can be completely described by its mean and variance.

Question #8 of 32 Question ID: 438800

Which of the following statements about probability distributions is least accurate?

✓ A) A probability distribution is, by definition, normally distributed.

✗ B) A probability distribution includes a listing of all the possible outcomes of an experiment.
✗ C) In a binomial distribution each observation has only two possible outcomes that are mutually
exclusive.

✗ D) One of the key properties of a probability function is 0 ≤ p ≤ 1.

Explanation

Probabilities must be zero or positive, but a probability distribution is not necessarily normally distributed. Binomial distributions
are either successes or failures.

Question #9 of 32 Question ID: 438805

The distribution of annual returns for a bond portfolio is approximately normal with an expected value of $120 million and a
standard deviation of $20 million. Which of the following is closest to the probability that the value of the portfolio one year from
today will be between $110 million and $170 million?

✓ A) 66%.
✗ B) 58%.

✗ C) 74%.
✗ D) 42%.

Explanation

Calculating z-values, z1 = (110 − 120) / 20 = −0.5. z2 = (170 − 120) / 20 = 2.5. Using the z-table, P(−0.5) = (1 − 0.6915) =
0.3085. P(2.5) = 0.9938. P(−0.5 < X < 2.5) = 0.9938 − 0.3085 = 0.6853. Note that on the exam, you will not have access to
z-tables, so you would have to reason this one out using the normal distribution approximations. You know that the probability
within +/− 1 standard deviation of the mean is approximately 68%, meaning that the area within −1 standard deviation of the
mean is 34%. Since −0.5 is half of −1, the area under −0.5 to 0 standard deviations under the mean is approximately 34% / 2 =
17%. The probability under +/− 2.5 standard deviations of the mean is approximately 99%. The value $170 is mid way between
+2 and +3 standard deviations, so the probability between these values must be (99% / 2) = 2%. The value from 0 to 2.5

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standard deviations must therefore be (99% / 2) − (2% / 2) = 48.5%. Adding these values gives us an approximate probability of
(48.5% + 17%) = 65.5%.

Question #10 of 32 Question ID: 438815

The central limit theorem concerns the sampling distribution of the:

✗ A) sample standard deviation.

✗ B) population mean.
✗ C) population standard deviation.
✓ D) sample mean.

Explanation

The central limit theorem tells us that for a population with a mean m and a finite variance σ2, the sampling distribution of the
sample means of all possible samples of size n will approach a normal distribution with a mean equal to m and a variance equal
to σ2 / n as n gets large.

Question #11 of 32 Question ID: 438808

Which one of the following statements about the t-distribution is most accurate?

✓ A) The t-distribution approaches the standard normal distribution as the number of degrees of
freedom becomes large.
✗ B) Compared to the normal distribution, the t-distribution is flatter with less area under the tails.
✗ C) Compared to the normal distribution, the t-distribution is more peaked with more area under the tails.
✗ D) The t-distribution is the appropriate distribution to use when constructing confidence intervals based
on large samples.

Explanation

As the number of degrees of freedom grows, the t-distribution approaches the shape of the standard normal distribution.
Compared to the normal distribution, the t-distribution is less peaked with more area under the tails. When choosing a
distribution, three factors must be considered: sample size, whether population variance is known, and if the distribution is
normal.

Question #12 of 32 Question ID: 438787

For a normal distribution, what approximate percentage of the observations falls within ± 2 standard deviations of the mean?

✗ A) 92%.

✗ B) 90%.
✓ C) 95%.
✗ D) 99%.

Explanation

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For normal distributions, approximately 95 percent of the observations fall within ± 2 standard deviations of the mean.

Question #13 of 32 Question ID: 438799

Regarding a binomially distributed random variable, the variance of the number of successes, X, where n equals the number of
trials and p equals the probability of success, is most likely equal to:

✗ A) np.
✗ B) p.
✗ C) p(1-p).
✓ D) np(1 - p).

Explanation

For a given series of n trials, the variance of X for a binomial random variable is equal to: np(1 - p) = npq, where q is the
probability of failure.

Question #14 of 32 Question ID: 438796

An investment has a mean return of 15% and a standard deviation of returns equal to 10%. Which of the following statements is least
accurate? The probability of obtaining a return:

✗ A) greater than 35% is 0.025.

✓ B) greater than 25% is 0.32.

✗ C) between 5% and 25% is 0.68.

✗ D) less than 5% is 0.16.

Explanation

Sixty-eight percent of all observations fall within +/- one standard deviation of the mean of a normal distribution. Given a mean of 15 and
a standard deviation of 10, the probability of having an actual observation fall within one standard deviation, between 5 and 25, is 68%.
The probability of an observation greater than 25 is half of the remaining 32%, or 16%. This is the same probability as an observation
less than 5. Because 95% of all observations will fall within 20 of the mean, the probability of an actual observation being greater than 35
is half of the remaining 5%, or 2.5%.

Question #15 of 32 Question ID: 438793

The return on a portfolio is normally distributed with a mean return of 8 percent and a standard deviation of 18 percent. Which of
the following is closest to the probability that the return on the portfolio will be between -27.3 percent and 37.7 percent?

✓ A) 92.5%.
✗ B) 68.0%.

✗ C) 81.5%.
✗ D) 96.5%.

Explanation

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Note that if you memorize the basic intervals for a normal distribution, you do not need a normal distribution table to answer this
question. -27.3% represents a loss of -35.3% from the mean return (-27.3 - 8.0), which is (-35.3/18) = -1.96 standard deviations
to the left of the mean. For a normal distribution, we know that approximately 95 percent of all observations lie with +/- 1.96
standard deviations of the mean, so the probability that the return is between -27.3% and 8.0% must be (95%/2) = 47.5%. A
return of 37.7 percent represents a gain of (37.7 - 8.0) = 29.7% from the mean return, which is (29.7/18) = 1.65 standard
deviations to the right of the mean. For a normal distribution, we know that approximately 90 percent of all observations lie with
+/- 1.65 standard deviations of the mean, so the probability that the return is between 8.0% and 37.7% must be (90%/2) = 45%.
Therefore the probability that the return is between -27.3 percent and 37.7 percent = (47.5% + 45%) = 92.5%.

Question #16 of 32 Question ID: 438798

The lower limit of a normal distribution is:

✗ A) negative one.
✗ B) zero.
✗ C) one.
✓ D) negative infinity.

Explanation

By definition, a true normal distribution has a positive probability density function from negative to positive infinity.

Question #17 of 32 Question ID: 438810

With 60 observations, what is the appropriate number of degrees of freedom to use when carrying out a statistical test on the
mean of a population?

✓ A) 59.
✗ B) 60.
✗ C) 58.

✗ D) 61.

Explanation

When performing a statistical test on the mean of a population based on a sample of size n, the number of degrees of freedom is
n - 1 since once the mean is estimated from a sample there are only n - 1 observations that are free to vary. In this case the
appropriate number of degrees of freedom to use is 60 - 1 = 59.

Question #18 of 32 Question ID: 438797

Approximately 50 percent of all observations for a normally distributed random variable fall in the interval:

✗ A) µ ± 2σ
✓ B) µ ± 0.67σ
✗ C) µ ± σ
✗ D) µ ± 3σ

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Explanation

µ ± 0.67σ

Question #19 of 32 Question ID: 438806

The annual returns for a portfolio are normally distributed with an expected value of £50 million and a standard deviation of £25
million. What is the probability that the value of the portfolio one year from today will be between £91.13 million and £108.25
million?

✗ A) 0.075.
✗ B) 0.090.
✓ C) 0.040.
✗ D) 0.025.

Explanation

Calculate the standardized variable corresponding to the outcomes. Z1 = (91.13 − 50) / 25 = 1.645, and Z2 = (108.25 − 50) / 25 =
2.33. The cumulative normal distribution gives cumulative probabilities of F(1.645) = 0.95 and F(2.33) = 0.99. The probability that
the outcome will lie between Z1 and Z2 is the difference: 0.99 − 0.95 = 0.04. Note that even though you will not have a z-table on
the exam, the probability values for 1.645 and 2.33 are commonly used values that you should have memorized.

Question #20 of 32 Question ID: 438809

When is the t-distribution the appropriate distribution to use? The t-distribution is the appropriate distribution to use when
constructing confidence intervals based on:

✗ A) small samples from populations with known variance that are at least approximately normal.
✗ B) large samples from populations with known variance that are nonnormal.
✓ C) small samples from populations with unknown variance that are at least approximately normal.
✗ D) large samples from populations with known variance that are at least approximately normal.

Explanation

The t-distribution is the appropriate distribution to use when constructing confidence intervals based on small samples from
populations with unknown variance that are either normal or approximately normal.

Question #21 of 32 Question ID: 438817

To apply the central limit theorem to the sampling distribution of the sample mean, the sample is usually considered to be large if n
is greater than:

✓ A) 30.
✗ B) 25.
✗ C) 15.

✗ D) 20.

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Explanation

A sample size is considered sufficiently large if it is larger than or equal to 30.

Question #22 of 32 Question ID: 438795

Which of the following statements is incorrect regarding a Bernoulli distributed random variable.

I. It only has three possible outcomes.

II. It is commonly used for assessing whether or not a company defaults during a specified time period.

✗ A) Neither I nor II.

✓ B) I only.
✗ C) Both I and II.
✗ D) II only.

Explanation

Bernoulli distributed random variable only has two possible outcomes. The outcomes can be defined as either a "success" or a
"failure."

Question #23 of 32 Question ID: 438803

A client will move his investment account unless the portfolio manager earns at least a 10% rate of return on his account. The
rate of return for the portfolio that the portfolio manager has chosen has a normal probability distribution with an expected return
of 19% and a standard deviation of 4.5%. What is the probability that the portfolio manager will keep this account?

✗ A) 1.000.
✗ B) 0.950.

✓ C) 0.977.
✗ D) 0.750.

Explanation

Since we are only concerned with values that are below a 10% return this is a 1 tailed test to the left of the mean on the normal
curve. With μ = 19 and σ = 4.5, P(X ≥ 10) = P(X ≥ μ − 2σ) therefore looking up -2 on the cumulative Z table gives us a value of
0.0228, meaning that (1 − 0.0228) = 97.72% of the area under the normal curve is above a Z score of -2. Since the Z score of
-2 corresponds with the lower level 10% rate of return of the portfolio this means that there is a 97.72% probability that the
portfolio will earn at least a 10% rate of return.

Question #24 of 32 Question ID: 438792

A group of investors wants to be sure to always earn at least a 5% rate of return on their investments. They are looking at an investment
that has a normally distributed probability distribution with an expected rate of return of 10% and a standard deviation of 5%. The
probability of meeting or exceeding the investors' desired return in any given year is closest to:

✗ A) 34%.

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 ✗ B) 98%.

✓ C) 84%.

✗ D) 50%.

Explanation

The mean is 10% and the standard deviation is 5%. You want to know the probability of a return 5% or better. 10% - 5% = 5% , so 5%
is one standard deviation less than the mean. Thirty-four percent of the observations are between the mean and one standard deviation
on the down side. Fifty percent of the observations are greater than the mean. So the probability of a return 5% or higher is 34% + 50%
= 84%.

Question #25 of 32 Question ID: 438786

Which of the following statements about the normal probability distribution is most accurate?

✗ A) Sixty-eight percent of the area under the normal curve falls between 0 and +1 standard
deviations above the mean.

✗ B) The standardized normal distribution has a mean of zero and a standard deviation of 10.
✓ C) Five percent of the normal curve probability falls more than outside two standard deviations from the
mean.

✗ D) The normal curve is asymmetrical about its mean.

Explanation

The normal curve is symmetrical with a mean of zero and a standard deviation of 1 with 34% of the area under the normal curve
falling between 0 and +1 standard deviation above the mean. Ninety-five percent of the normal curve is within two standard
deviations of the mean, so five percent of the normal curve falls outside two standard deviations from the mean.

Question #26 of 32 Question ID: 438811

Which one of the following distributions is described entirely by the degrees of freedom?

✗ A) Lognormal distribution.
✓ B) Student's t-distribution.

✗ C) Binomial distribution.
✗ D) Normal distribution.

Explanation

Student's t-distribution is defined by a single parameter known as the degrees of freedom.

Question #27 of 32 Question ID: 438791

A call center receives an average of two phone calls per hour. The probability that they will receive 20 calls in an 8-hour day is
closest to:

✗ A) 3.66%.

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 ✗ B) 16.56%.
✗ C) 6.40%.
✓ D) 5.59%.

Explanation

To solve this question, we first need to realize that the expected number of phone calls in an 8-hour day is λ = 2 × 8 = 16. Using
the Poisson distribution, we solve for the probability that X will be 20.

P(X = x) = (λxe-λ) / x!

P(X = 20) = (1620e-16) / 20! = 0.0559 = 5.59%

Question #28 of 32 Question ID: 438794

The probability of returns less than −10%, assuming a normal distribution with expected return of 6.5% and standard deviation of
10%, is:

✓ A) approximately 5%.
✗ B) not defined with only this information.
✗ C) approximately 10%.
✗ D) less than 2.5%.

Explanation

−10 is 16.5% below the mean return, (16.5 / 10) = 1.65 standard deviations, which leaves approximately 5% of the possible
outcomes in the left tail below −10%.

Question #29 of 32 Question ID: 438807

Which statement best describes the properties of Student's t-distribution? The t-distribution is:

✗ A) symmetrical, defined by two parameters and is less peaked than the normal distribution.
✓ B) symmetrical, defined by a single parameter and is less peaked than the normal distribution.
✗ C) skewed, defined by a single parameter and is more peaked than the normal distribution.

✗ D) skewed, defined by a single parameter and is less peaked than the normal distribution.

Explanation

The t-distribution is symmetrical like the normal distribution but unlike the normal distribution is defined by a single parameter
known as the degrees of freedom and is less peaked than the normal distribution.

Questions #30-31 of 32

A study of hedge fund investors found that their household incomes are normally distributed with a mean of $280,000 and a
standard deviation of $40,000.

Question #30 of 32 Question ID: 438813

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The percentage of hedge fund investors that have incomes greater than $350,000 is closest to:

✗ A) 5.0%.
✗ B) 3.0%.
✓ C) 4.0%.
✗ D) 25.0%.

Explanation

z = (350,000 - 280,000)/40,000 = 1.75. Using the z-table, F(1.75) = 0.9599. So, the percentage greater than $350,000 = (1 -
0.9599) = 4.0%.

Question #31 of 32 Question ID: 438814

The percentage of hedge fund investors with income less than $180,000 is closest to:

✗ A) 6.48%.
✗ B) 1.15%.
✗ C) 2.50%.
✓ D) 0.62%.

Explanation

z = (180,000 - 280,000)/40,000 = -2.50. Using the z-table, F(-2.50) = (1 - 0.9938) = 0.62%.

Question #32 of 32 Question ID: 438801

A food retailer has determined that the mean household income of her customers is $47,500 with a standard deviation of $12,500. She is
trying to justify carrying a line of luxury food items that would appeal to households with incomes greater than $60,000. Based on her
information and assuming that household incomes are normally distributed, what percentage of households in her customer base has
incomes of $60,000 or more?

✓ A) 15.87%.
✗ B) 34.13%.

✗ C) 2.50%.

✗ D) 5.00%.

Explanation

Z = ($60,000 - $47,500) / $12,500 = 1.0

From the table of areas under the normal curve, 84.13% of observations lie to the left of +1 standard deviation of the mean. So, 100% -
84.13% = 15.87% with incomes of $60,000 or more.

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