Assignment 1

Name

Course

Institution

Date
 Assignment 1

Problem One

A)

The expected value rule is the most rational. This is because of the fact that it accounts

for all possible outcomes and their probabilities. With these, it tends to lead balanced decision-

making process (Kaplan Financial Knowledge Bank, n.d.). This is unlike minimax whose main

focus is trying to avoid the worst-case scenario, or maximax, which focuses on the best-case

scenario.

B)

Expected value is a calculation based purely on objective probabilities and monetary

outcomes. On the other hand, expected utility that includes subjective preferences for risk and

outcomes (Bakker & de Weijs, 2019). Needless to mention, expected utility is typically more

rational to maximize because it reflects personal attitudes toward risk and well-being rather than

just financial gain.

C)

The relationship between utility and risk is that utility functions reflect an individual's

risk preferences. Risk-averse individuals prefer safer outcomes with lower variance. On the other

hand, risk-seeking individuals show a preference for more risk (Bokern et al., 2021). Utility

helps quantify how individuals value outcomes under uncertainty.

D)
 Risk averse individuals prefer guaranteed outcomes over uncertain ones with the same

expected value. Risk seeking individuals prefer uncertain outcomes with the possibility of higher

rewards over guaranteed ones (Chan et al., 2020). Risk neutral individuals are indifferent

between certain and uncertain outcomes if the expected value is the same.

Question Two

A)

1. P(A) ≥ 0 for any event A (non-negative probability).

2. P(S)=1, where S is the sample space (probabilities sum to 1).

3. For mutually exclusive events A and B, P(A∪B) = P(A) + P(B) (additivity for disjoint

events).

B)

The sum of probabilities ((0.6, 0.8, 0.6) exceeds 1. This violates the second condition of a

legitimate probability function. To fix this, adjust the values so that they sum to 1, e.g., rescaling

them proportionally.

C)

Union formula: P(A∪B) = P(A) + P(B) − P(A∩B)

Using the values provided: P(A∪B) = 0.3 + 0.5−0.1 = 0.7

D)

Probability of neither event A nor B:

Given P(A)=0.6P, P(B)=0.8, and P(A∩B) =0.5

P(A∪B) = P(A)+P(B)−P(A∩B)

=0.6+0.8−0.5=0.9

Thus, P (Neither A nor B) =1−0.9 = 0.1

E)

Conditional probability of A given B:

P ( A ∩B) 0.15
P(A∣B) = =
P( B) 0.5

= 0.5

Problem Three

To find P (Disease Positive Test) I will use the Bayers Rule

P ( PositiveTest ) P(PositiveTest ∣ Disease) ⋅ P( Disease)

Where:

 P (Positive Test∣Disease) =0.96

 P (Positive Test∣No Disease) =1−0.9 = 0.03

 P (No Disease) =0.99

P (Positive Test) = (0.96⋅0.01) + (0.03⋅0.99)

= 0.0096 + 0.0297 = 0.0393

0.96∗0.01
P (Disease Positive Test) =
0.0393

0.244

Question Four

A)

The binomial distribution is written as

P (X = k) = ( nk)p (1-P)
k n-k

 X: Random variable representing the number of successes.

 n: Parameter representing the number of trials.

 p: Parameter representing the probability of success in each trial.

B)

P (X = 3) = (63)(0.7) 3
(03)3
 =20 × (0.7)3 × (0.3)3

C)

The normal distribution is written as:

1 2 ¿
f (x) = e-( x−u ¿ 2
δ √2 π 2∂

 x: Random variable.

 μ: Parameter (mean).

 σ; Parameter (standard deviation).

 e and π: Constants.

D)

Convert to a Z-score:

70−20
Z=
10
=2

The probability of Z >2 is approximately 0.0228.

E)

Convert to a Z-score:

6−10
Z=
2
= -2
 The probability of Z > -2 is approximately - 0.0228.

Problem 5

A. False

B. True

C. False

D. True

E. False
 References

Kaplan Financial Knowledge Bank. (n.d.). Maximax, maximin and minimax regret. Kaplan UK.

Retrieved from

https://kfknowledgebank.kaplan.co.uk/cima/management-accounting/decision-making/

maximax-maximin-and-minimax

Bokern, P., Linde, J., Riedl, A., Schmeets, H., & Werner, P. (2021). A survey of risk preference

measures and their relation to eld behavior.

Chan, R. H., Clark, E., Guo, X., & Wong, W. K. (2020). New development on the third-order

stochastic dominance for risk-averse and risk-seeking investors with application in risk

management. Risk Management, 22(2), 108-132.

Bakker, M., & de Weijs, R. J. (2019). Basic Introduction to Expected Value Analyses and

Investments Through the Corporate Form. Amsterdam Law School Research Paper,

(2019-04).