Statistics For Managers Using Microsoft Excel: (3 Edition)

Statistics for Managers
Using Microsoft Excel

(3rd Edition)
Chapter 4
Basic Probability and Discrete
Probability Distributions
© 2002 Prentice-Hall, Inc. Chap 4-1

Chapter Topics
 Basic probability concepts
 Sample spaces and events, simple probability, joint
probability
 Conditional probability
 Statistical independence, marginal probability
 Bayes’s Theorem
Chap 4-2
© 2002 Prentice-Hall, Inc.
Chapter Topics
(continued)
 The probability of a discrete random variable

 Covariance and its applications in finance
 Binomial distribution
 Poisson distribution
 Hypergeometric distribution
Chap 4-3
Sample Spaces
 Collection of all possible outcomes
 e.g.: All six faces of a die:
 e.g.: All 52 cards in a deck:
Chap 4-4
Events
 Simple event
 Outcome from a sample space with one
characteristic
 e.g.: A red card from a deck of cards
 Joint event
 Involves two outcomes simultaneously
 e.g.: An ace that is also red from a deck of
cards
Chap 4-5
Visualizing Events
 Contingency Tables
Ace Not Ace Total
Black 2 24 26
Red 2 24 26
Total 4 48 52
 Tree Diagrams Ace

Red
Full Cards Not an Ace
Deck Black Ace
of Cards Cards
Not an Ace Chap 4-6
Simple Events
The Event of a Triangle
There are 5 triangles in this collection of 18 objects

Chap 4-7
Joint Events
The event of a triangle AND blue in color
Two triangles that are blue

Chap 4-8
Special Events
Null Event
 Impossible event 
e.g.: Club & diamond on one card
draw
 Complement of event
 For event A, all events not in A
 Denoted as A’
 e.g.: A: queen of diamonds
A’: all cards in a deck that are
not queen of diamonds
Chap 4-9
Special Events
(continued)
 Mutually exclusive events
 Two events cannot occur together
 e.g.: -- A: queen of diamonds; B: queen of clubs
 Events A and B are mutually exclusive
 Collectively exhaustive events
 One of the events must occur
 The set of events covers the whole sample space
 e.g.: -- A: all the aces; B: all the black cards; C: all the diamonds; D:
all the hearts
 Events A, B, C and D are collectively exhaustive
 Events B, C and D are also collectively
exhaustive
Chap 4-10
Contingency Table
A Deck of 52 Cards
Red Ace
Not an Total
Ace
Ace
Red 2 24 26
Black 2 24 26
Total 4 48 52
Sample Space
Chap 4-11
Tree Diagram
Event Possibilities
Ace
Red
Cards Not an Ace
Full
Deck
Ace
of Cards
Black
Cards Not an Ace
Chap 4-12
Probability
 Probability is the numerical 1 Certain
measure of the likelihood
that an event will occur
 Value is between 0 and 1
.5
 Sum of the probabilities of
all mutually exclusive and
collective exhaustive events
is 1
0 Impossible
Chap 4-13
Computing Probabilities
The probability of an event E:


number of event outcomes

P( E ) 
total number of possible outcomes in the sample space
X

T e.g. P( ) = 2/36
(There are 2 ways to get one 6 and the other 4)
 Each of the outcomes in the sample space is

equally likely to occur
Chap 4-14
Computing Joint Probability
 The probability of a joint event, A and B:
P(A and B) = P(A  B )
number of outcomes from both A and B

total number of possible outcomes in sample space
E.g. P(Red Card and Ace)

2 Red Aces 1
 
52 Total Number of Cards 26
Chap 4-15
Joint Probability Using
Contingency Table
Event
Event B1 B2 Total
A1 P(A1 and B1) P(A1 and B2) P(A1)
Total P(B1) P(B2) 1
Joint Probability Marginal (Simple) Probability
Chap 4-16
Computing Compound
Probability
 Probability of a compound event, A or B:
P( A or B )  P( A  B )
number of outcomes from either A or B or both

total number of outcomes in sample space
E.g. P(Red Card or Ace)
4 Aces + 26 Red Cards - 2 Red Aces

52 total number of cards
28 7
 
52 13
Chap 4-17
Compound Probability
(Addition Rule)
P(A1 or B1 ) = P(A1) + P(B1) - P(A1 and B1)
Event
Event B1 B2 Total
Total P(B1) P(B2) 1
For Mutually Exclusive Events: P(A or B) = P(A) + P(B)
Chap 4-18
Computing Conditional
Probability
 The probability of event A given that event B
has occurred:
P ( A and B )
P( A | B) 
P( B)
E.g.
P(Red Card given that it is an Ace)
2 Red Aces 1
 
4 Aces 2
Chap 4-19
Conditional Probability Using
Contingency Table
Color
Type Red Black Total
Ace 2 2 4
Non-Ace 24 24 48
Total 26 26 52
Revised Sample Space

P(Ace and Red) 2 / 52 2
P(Ace | Red)   
P(Red) 26 / 52 26
Chap 4-20
Conditional Probability and
Statistical Independence
 Conditional probability:
P ( A and B)
P( A | B) 
P( B)
 Multiplication rule:
P( A and B)  P( A | B) P( B)
 P( B | A) P( A)
Chap 4-21
Conditional Probability and
Statistical Independence
(continued)
 Events A and B are independent if

P( A | B )  P( A)
or P( B | A)  P( B)
or P( A and B)  P( A) P( B)
 Events A and B are independent when the
probability of one event, A, is not affected by
another event, B
Chap 4-22
Bayes’s Theorem
P  A | Bi  P  Bi 
P  Bi | A  
P  A | B1  P  B1       P  A | Bk  P  Bk 
P  Bi and A 

P  A Adding up
the parts
Same of A in all
Event the B’s
Chap 4-23
Bayes’s Theorem
Using Contingency Table
Fifty percent of borrowers repaid their loans. Out of those
who repaid, 40% had a college degree. Ten percent of
those who defaulted had a college degree. What is the
probability that a randomly selected borrower who has a
college degree will repay the loan?
P  R   .50 P  C | R   .4 P  C | R   .10
P R |C  ?
Chap 4-24
Bayes’s Theorem
Using Contingency Table
(continued)
Repay Repay Total
College .2 .05 .25
College .3 .45 .75

Total .5 .5 1.0
P  C | R P  R
P R | C 
P  C | R P  R  P  C | R  P  R 

 .4   .5 

.2
 .8
 .4   .5   .1  .5  .25
Chap 4-25
Random Variable
 Random Variable
 Outcomes of an experiment expressed numerically
 e.g.: Toss a die twice; count the number of times
the number 4 appears (0, 1 or 2 times)
Chap 4-26
Discrete Random Variable
 Discrete random variable
 Obtained by counting (1, 2, 3, etc.)
 Usually a finite number of different values
 e.g.: Toss a coin five times; count the number of
tails (0, 1, 2, 3, 4, or 5 times)
Chap 4-27
Discrete Probability
Distribution Example
Event: Toss two coins Count the number of tails
Probability Distribution
Values Probability
T 0 1/4 = .25
1 2/4 = .50
T 2 1/4 = .25
T T
Chap 4-28
Discrete Probability Distribution
 List of all possible [Xj , p(Xj) ] pairs
 Xj = value of random variable
 P(Xj) = probability associated with value
 Mutually exclusive (nothing in common)
 Collectively exhaustive (nothing left out)
0  P X j  1  P X  1j
Chap 4-29
Summary Measures
 Expected value (the mean)
 Weighted average of the probability distribution

  E  X    X jP X j 
j
 e.g.: Toss 2 coins, count the number of tails,

compute expected value
   X jP X j 
j
  0   2.5    1  .5    2   .25   1
Chap 4-30
Summary Measures
(continued)
 Variance
 Weight average squared deviation about the mean
  E  X        X j    P  X j 
2 2 2

 
 e.g. Toss two coins, count number of tails,
compute variance
   X j    P X j 
2 2
  0  1  .25    1  1  .5    2  1  .25   .5
2 2 2
Chap 4-31
Covariance and its Application
N
 XY    X i  E  X   Yi  E  Y  P  X iYi 
i 1
X : discrete random variable

X i : i th outcome of X
Y : discrete random variable
Yi : i th outcome of Y
P  X iYi  : probability of occurrence of the i th
outcome of X and the i th outcome of Y
Chap 4-32
Computing the Mean for
Investment Returns
Return per $1,000 for two types of investments
Investment
P(XiYi) Economic condition Dow Jones fund X Growth Stock Y
.2 Recession -$100 -$200
.5 Stable Economy + 100 + 50
.3 Expanding Economy + 250 + 350
E  X    X   100   .2    100   .5    250   .3  $105
E  Y   Y   200   .2    50   .5    350   .3   $90

Chap 4-33
Computing the Variance for
Investment Returns
Investment
.2 Recession -$100 -$200
   100  105   .2    100  105   .5    250  105   .3 

2 2 2 2
X
 14, 725  X  121.35

   200  90   .2    50  90   .5    350  90   .3 
2 2 2 2
Y
 37,900  Y  194.68
Chap 4-34
Computing the Covariance for
Investment Returns
Investment
.2 Recession -$100 -$200
 XY   100  105   200  90   .2    100  105   50  90   .5 

  250  105   350  90   .3  23,300
The Covariance of 23,000 indicates that the two investments are
positively related and will vary together in the same direction.
Chap 4-35
Important Discrete
Probability Distributions
Discrete Probability
Distributions
Binomial Hypergeometric Poisson
Chap 4-36
Binomial Probability Distribution
 ‘n’ identical trials
 e.g.: 15 tosses of a coin; ten light bulbs taken from
a warehouse
 Two mutually exclusive outcomes on each
trials
 e.g.: Head or tail in each toss of a coin; defective
or not defective light bulb
 Trials are independent
 The outcome of one trial does not affect the
outcome of the other
Chap 4-37
Binomial Probability Distribution
(continued)
 Constant probability for each trial

 e.g.: Probability of getting a tail is the same each
time we toss the coin
 Two sampling methods
 Infinite population without replacement
 Finite population with replacement
Chap 4-38
Binomial Probability
Distribution Function
n!
P X   p  1 p
X n X
X ! n  X  !
P  X  : probability of X successes given n and p
X : number of "successes" in sample  X  0,1, , n 
p : the probability of each "success"
n : sample size Tails in 2 Tosses of Coin
X P(X)
0 1/4 = .25
1 2/4 = .50
2 1/4 = .25 Chap 4-39
Binomial Distribution
Characteristics
 Mean
   E  X   np
 
 E.g.   np  5 .1  .5
 Variance and P(X) n = 5 p = 0.1

Standard Deviation .6
.4

 2  np  1  p  .2
0 X
  np  1  p  0 1 2 3 4 5
 E.g.
  np  1  p   5  .1  1  .1  .6708
Chap 4-40
Binomial Distribution in PHStat
 PHStat | probability & prob. Distributions |
binomial
 Example in excel spreadsheet
Microsoft Excel
Worksheet
Chap 4-41
Poisson Distribution
 Poisson Process: P( X  x |
 Discrete events in an “interval” e- x
 The probability of One Success
in an interval is stable x!
 The probability of More than
One Success in this interval is 0
 The probability of success is
independent from interval to
interval
 e.g.: number of customers arriving in 15 minutes
 e.g.: number of defects per case of light bulbs
Chap 4-42
Poisson Probability
Distribution Function

e  X
P X  
X!
P  X  : probability of X "successes" given 
X : number of "successes" per unit
 : expected (average) number of "successes"
e : 2.71828 (base of natural logs)
e.g.: Find the probability of 4 e 3.6 3.64
customers arriving in 3 minutes P X    .1912
4!
when the mean is 3.6.
Chap 4-43
Poisson Distribution in PHStat
Poisson
Microsoft Excel
Worksheet
Chap 4-44
Poisson Distribution
Characteristics
 Mean .6
P(X) = 0.5

  E X    .4
.2
N 0 X
  XiP  Xi  0 1 2 3 4 5
i 1
P(X) = 6
 Standard Deviation .6
.4
and Variance .2

 2
  0 X
0 2 4 6 8 10
Chap 4-45
Hypergeometric Distribution
 “n” trials in a sample taken from a finite
population of size N
 Sample taken without replacement
 Trials are dependent
 Concerned with finding the probability of “X”
successes in the sample where there are “A”
successes in the population
Chap 4-46
Function
 A   N  A E.g. 3 Light bulbs were
 X  n  X  selected from 10. Of the 10
P X     
there were 4 defective. What
N
  is the probability that 2 of the
n  3 selected are defective?
P  X  : probability that X successes given n, N , and A
n : sample size  4  6 
  
N : population size  2  1 
P  2   .30
A : number of "successes" in population 10 
 
X : number of "successes" in sample 3 
 X  0,1, 2, , n  Chap 4-47

Characteristics
 Mean
A

  E X   n
N
 Variance and Standard Deviation
nA  N  A  N  n Finite

 
2
Population
N2 N 1 Correction
Factor
nA  N  A  N n

N 2
N 1
Chap 4-48
Hypergeometric Distribution in
PHStat
Hypergeometric …
Microsoft Excel
Worksheet
Chap 4-49
Chapter Summary
 Discussed basic probability concepts
 Sample spaces and events, simple probability,
and joint probability
 Defined conditional probability
 Statistical independence, marginal probability
 Discussed Bayes’s theorem
Chap 4-50
Chapter Summary
(continued)
 Addressed the probability of a discrete

random variable
 Defined covariance and discussed its
application in finance
 Discussed binomial distribution
 Addressed Poisson distribution
 Discussed hypergeometric distribution
Chap 4-51

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Statistics for Managers

Using Microsoft Excel

© 2002 Prentice-Hall, Inc. Chap 4-1

 The probability of a discrete random variable

 e.g.: All 52 cards in a deck:

 Tree Diagrams Ace

There are 5 triangles in this collection of 18 objects

Two triangles that are blue

The probability of an event E:

number of event outcomes

 Each of the outcomes in the sample space is

E.g. P(Red Card and Ace)

Total P(B1) P(B2) 1

Joint Probability Marginal (Simple) Probability

Total P(B1) P(B2) 1

For Mutually Exclusive Events: P(A or B) = P(A) + P(B)

Revised Sample Space

 Events A and B are independent if

Repay Repay Total

College .2 .05 .25

College .3 .45 .75

 e.g.: Toss 2 coins, count the number of tails,

X : discrete random variable

E  X    X   100   .2    100   .5    250   .3  $105

E  Y   Y   200   .2    50   .5    350   .3   $90

   100  105   .2    100  105   .5    250  105   .3 

 14, 725  X  121.35

 XY   100  105   200  90   .2    100  105   50  90   .5 

Binomial Hypergeometric Poisson

 Constant probability for each trial

 Variance and P(X) n = 5 p = 0.1

 X  0,1, 2, , n  Chap 4-47

 Addressed the probability of a discrete

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