Question

Question 5. Under the assumptions of normality and rationality, what is the probability to observe negative returns from Country A? What is the expected loss at the 5% level? What can you advise based on these predictions?

Question 6. Under the assumptions of normality and rationality, what is the probability to observe negative returns from Country B? What is the expected loss at the 10% level? What can you advise based on these predictions? (8marks)

µ_A ≈ 1.976

µ_B = 2.25

σ²_A = 2.5625

σ²_B = 4.64

Answer 1

Let rA and rB be the returns from Company A and B respectively.

So, According to the question: rA ~ N(µA, σ2A)

and, rB ~ N(µB, σ2B)

Ans 5) Probability to observe negative returns from country A = P(rA < 0)

  

  

  

= 1 - 0.89065 = 0.10935 = 10.94%

Let us assume, Expected loss at 5% level for Comopany A = xA

This implies, probability that the return of company A lies between xA and 0 is 5% i.e. 0.05

Thus, the expected loss at 5% fpr Company A = 3.57

Ans 6) Probability to observe negative returns from country B = P(rB < 0)

  

  

  

= 1 - 0.85083 = 0.14917 = 14.92%

Let us assume, Expected loss at 10% level for Company B= xB

This implies, probability that the return of company B lies between xB and 0 is 10% i.e. 0.1

Thus, the expected loss at 10% for Company B = 3.71