Assignment 1

Business Statistics Term Project

Areesh Shahid
Haneefa Soomro
Sana Akbar Tak
Syed Marij Hussain
Tayyaba Sahar Rauf

1. A quality-control manager found that 30% of work-related problems occurred on Mondays and
that 20% occurred in the last hour of a day’s shift. It was also found that 4% of worker-related
problems occurred in the last hour of Monday’s shift.

a) What is the probability that a worker-related problem that occurs on a Monday does not occur in the
last hour of the day’s shift?

Notation Description Probability

M Problem on Monday 0.30
L Problem in Last Hour 0.20
NL Problem Not in Last Hour 0.80
M∩L Problem on Monday in Last Hour 0.04
M∩NL Problem on Monday Not in Last Hour 0.26

Bayes Theorem
P(M ∩ N L)
P(N
! L |M ) =
P(M )
0.26
!=
0.30
! = 0.867

b) Are the events “problem occurs on Monday” and “problem occurs in the last hour of the day’s shift”
statistically independent?

If the stated events were statistically independent, the probability of a Monday problem being in
the last hour (which is 1 - 0.867 = 0.133) would be the same as the probability of being in the last
hour on all days (which is 0.80).

Since the two probabilities are different, then "Problem occurs on Monday" and "Problem occurs
in the last hour of the day's shift" are not statistically independent.
2. Suppose the grades of students were normally distributed with a mean of 73 and a standard
deviation of 15.

a. If 10 % of her students failed the course and received Fs, what was the maximum score among those
who received an F?

μ
! = 73                                     

z! = 1 − 0.10 = 0.90           
σ! = 15     

Reading the table backwards corresponds to

Z=-1.28

x −μ x − 73
! −1.28 = = = 53.8 m ark s
σ 15

b. If 35 % of the students received grades of B or better (i.e., As and Bs), what is the minimum score of
those who received a B?

! = 73                                     
μ
z! = 1 − 0.35 = 0.65           
σ! = 15     

Reading the table backwards corresponds to

Z=0.39

x −μ x − 73
! 0.39 = = = 78.85 m ark s
σ 15
 10
20
30
40
50
60
70

0
0
10000
20000
30000
40000
50000
60000
Date
18/02/14 Date
04/04/14 19/02/14
22/05/14 08/04/14
08/07/14 27/05/14
using a line plot.

01/09/14 14/07/14
21/10/14 08/09/14
09/12/14 29/10/14
26/01/15 18/12/14
13/03/15 06/02/15
30/04/15 27/03/15
17/06/15 15/05/15
06/08/15 02/07/15
23/09/15 25/08/15
12/11/15 14/10/15
31/12/15 02/12/15
17/02/16 21/01/16
05/04/16 10/03/16
20/05/16 28/04/16
13/07/16 15/06/16

TRG Price
29/08/16 09/08/16

TRG Price
20/10/16 29/09/16

KSE-100 Index Price

06/12/16 18/11/16
KSE-100 Index Price

23/01/17 06/01/17
09/03/17 23/02/17
26/04/17 13/04/17
13/06/17 01/06/17
03/08/17 25/07/17
22/09/17 14/09/17
08/11/17 01/11/17
27/12/17 20/12/17
13/02/18 08/02/18
02/04/18 29/03/18
18/05/18 17/05/18
09/07/18 09/07/18
30/08/18 31/08/18
3. Gather Daily stock prices for KSE 100 index and TRG for past five years. Illustrate the data

18/10/18 22/10/18
05/12/18
a. Calculate average daily return, standard deviation for KSE Index and company stock prices.

AVG returns KSE

0.038%
100
AVG returns TRG 0.128%

St. Dev for KSE

0.009524242
100
St. Dev for TRG 0.029396903

b. Calculate Covariance and correlation between the two. Comment.

Covariance 0.000146059

Correlation 52.17%

Covariance provides insight into how two variables are related to one another. More precisely, covariance
refers to the measure of how two random variables in a data set will change together. This is a positive
covariance which means the two variables, KSE-100 index and TRG daily returns are positively
correlated and move in the same direction, albeit by a much different margin, as represented by a
significantly small covariance value.

Correlation standardizes the measure of interdependence between two variables and informs as to how
closely the two variables move together. In this instance, the two stocks daily returns s are 52.17 percent
correlated meaning, meaning they are positively moderately correlated.

c. Calculate annualized return and annualized standard deviation.

AVG returns KSE

9.299%
100
AVG returns TRG 0.127%

St. Dev for KSE

0.191743359
100
St. Dev for TRG 0.44062144

d. Calculate covariance and correlation based on (C). Comment.

Covariance 0.035860633

Correlation 42.45%
This is a positive covariance which means the two variables, KSE-100 index and TRG’s annualised
returns are positively correlated and move in the same direction, and by a much larger margin than the
daily returns. However, the two stocks annual returns’ correlation is 42.45 percent, which means that the
relation is still positively correlated but the degree of interdependence is lower in the annualised returns.

e. Based on your data, comment whether covariance based on annualized returns gives better results than
covariance based on daily returns or not. Explain

Covariance based on the annualized returns gives a much stronger relationship than the daily returns
which indicates that there is a stronger relationship between the two variables in the long run and even
though both are still positive, as in move in the same direction, but relatively more closely with the
annualised returns.

4. Explain Black Scholes Op2on Pricing Model? Under what circumstances, can it be used? Elaborate
on the applica2on and limita2ons related to the model?

Black-Scholes is a pricing model used to determine the fair price or theoretical value for a call or a put
option based on six variables such as volatility, type of option, underlying stock price, time, strike price,
and risk-free rate. The quantum of speculation is more in case of stock market derivatives, and hence
proper pricing of options eliminates the opportunity for any arbitrage. There are two important models for
option pricing – Binomial Model and Black-Scholes Model. The model is used to determine the price of a
European call option, which simply means that the option can only be exercised on the expiration date.

The model also relies on several underlying assumptions for it to work. These assumptions are as follows:
• The option can only be exercised upon expiration (i.e. it is a European style)
• The underlying security will sometimes go up in price and sometimes go down and that the
direction of the movement cannot be predicted.
• The underlying security pays no dividends
• The volatility of the underlying security remains stable during the period of the contract
• Interest rates remain constant during the period of the contract
• There are no commissions charged on the purchase or the sale of the option
• There is no arbitrage opportunity (i.e. neither the buyer nor the seller should gain an immediate
benefit)
Limitations:-

First, it isn't absolutely necessary to fully understand the mathematical formula behind the pricing model
to be successful at options trading and it's not even necessary that you use it at all. If you do wish to use it
though, you will probably find it easier to use one of the many Black Scholes model calculating tools on
the internet rather than carrying out the calculations yourself. You will find that a number of online
brokers include such a calculating tool for their customers to use.
Second, it should be noted that it should never be considered a precise indicator of the true value of an
option, because there are some problems with the assumptions that underpin the model. For example, it
assumes that interest rates and the volatility of the underlying security will remain constant during the
period of the contract, and this is unlikely to be the case.

It also doesn't take into account the fact that some stocks pay dividends, nor the extra value that American
style options have because the holder of them is able to exercise them at any point. There are, however,
variants of the Black Scholes model that can be applied to factor in such issues.

If you do plan on using the model as part of your trading strategy, then we strongly suggest that you don't
rely upon it to return exact values, but rather theoretical values. These theoretical values can then be used
for the purposes of comparing options to assist you in determining what trades you should be making.
You could also use the model to help decide whether a potential trade you have identified through other
methods is likely to be a successful trade or not.

In summary, the Black Scholes pricing model has played a notable part in how the options market and
options trading have developed and it certainly still has its uses to traders. You should, however, be fully
aware of its limitations and never be entirely dependent on it.

5. The professor in a statistics course takes a random sample of 100 students from campus to
determine the number in favor of multiple-choice tests. Suppose that 50 % of the entire college
population are actually in favor of the multiple choice test. What is the probability that more
than 50 % of the students sampled will favor the multiple-choice test?

! Mea n = n P = 100(0.5) = 50

! Std . De v . = n PQ

n! PQ = 100(.50)(.50) = 5
50 − 50
! P(X > 50 | n = 100,P = 0.5) = P(Z > )
5

! = (Z > 0)
P
! = 0.5

The probability that more than 50% of the students will favour the multiple-choice test is 0.5.
6. W is a normally distributed random variable with mean 0 and variance 1, and V is a x2
distributed random variable with degrees of freedom (n -1). How can both t and F distributions
be defined in terms of the variables W and V?
W ~ N (0,1)
2
V ~ !xn−1

Note: A simple Chi-Squared distribution is the squares of a standard normal distribution. Since W ~
N(0,1) is a standard normal distribution, we can say that

!W 2 ~ x12

The subscript 1 shows that this particular chi-squared distribution is constructed only from 1 standard
normal distribution.

For t distribution, we know that a t distribution with a very large number of d.o.f (>>(n-1)) approximates
a normal distribution, we can say that
• W ~ t(n-1), where n is very large

• ! V  ~ t(n-1), where n is very large

For F distribution, we know that an f distribution is the ratio of two independent chi-squared
distributions, when each of them is divided by its degrees of freedom.
W2
1
i.e. !  V
 ~ F(1,n − 1)
n−1

assuming !W 2 ~ x12

to be a chi squared distribution of W ~ N(0,1), as mentioned previously.