Tutorial 4
1.
(0.5p)
The risk of a portfolio of financial assets is sometimes called
investment risk
(Radcliffe, 1994). In general, investment risk is typically measured by computing the variance
or standard deviation of the probability distribution that describes the decision maker's
potential outcomes (gains or losses). The greater the variation in potential outcomes, the
greater the uncertainty faced by the decision maker; the smaller the variation in potential
outcomes, the more predictable the decision maker's gains or losses. The two discrete
probability distributions given in the table were developed from historical data. They describe
the potential total physical damage losses next year to the fleets of
delivery trucks of two different firms
.
FirmA
FirmB
Loss next year
Probability
Loss next year
Probability
$ 0
.01
$ 0
.00
500
.01
200
.01
1,000
.01
700
.02
1,500
.02
1,200
.02
2,000
.35
1,700
.15
2,500
.30
2,200
.30
3,000
.25
2,700
.30
3,500
.02
3,200
.15
4,000
.01
3,700
.02
4,500
.01
4,200
.02
5,000
.01
4,700
.01
a.
Verify that both firms have the same expected total physical damage loss.
b.
Compute the standard deviation of each probability distribution, and determine which
firm faces the greater risk of physical damage to its fleet next year.
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 Spring '12
 PetrIvanov
 Finance, Normal Distribution, Probability theory, probability density function, Discrete probability distribution, total physical damage

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