BZAN6310 - SP19 - Chapter - 4, 5

BZAN 6310: Quantitative Analysis for Business
Lecture 3. Probability and Normal Distribution
Dr. Jinghui (Jove) Hou

Introduction
• Events with uncertainty
• Chance of rain is 70%
• Odds against Rockets winning NBA championship is 8 to 1
• Chance of getting an A in BZAN6310 is ____.
• Probability of a product being successful is 0.95
• All are probability statements.

• Outcomes of an uncertain event are a random variable
• Has multiple possible values/outcomes.
• Each value/outcome has its corresponding probabilities.
4-2 Probability Essentials
 A probability is a number between 0 and 1 that measures the

likelihood that some event will occur.
 An event with probability 0 cannot occur, whereas an event with probability
1 is certain to occur.
 An event with probability greater than 0 and less than 1 involves
uncertainty, and the closer its probability is to 1, the more likely it is to occur.
 Probabilities are sometimes expressed as percentages or odds, but
these can be easily converted to probabilities on a 0-to-1scale.
 Chance of rain is 70%, then the probability of rain is 0.7.
 Odds against Rockets winning is 8 to 1, then the probability of Rockets
winning is 1/9 (or 0.11).
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4-2a Rule of Complements
 The simplest probability rule involves the complement of an event.

 If A is any event, then the complement of A, denoted by
 A-bar or in some books by Ac, is the event that A does not occur.
 If the probability of A is P(A), then the probability of its complement is
given by the equation below.
4-2a Rule of Complements
 A event: my revenue this year will be higher than that of last year
 P(A) = 0.8
Questions:
 What does mean?
 P(A)?
4-2b Addition Rule
 Events are mutually exclusive if at most one of them can occur—

that is, if one of them occurs, then none of the others can occur.
 Exhaustive events means they exhaust all possibilities—one of
the events must occur.
 The addition rule of probability:
 When the events are mutually exclusive, the probability that at least
one of the events will occur is the sum of their individual probabilities:
4-2b Addition Rule
 Event A1: my company’s revenue is less than $1M

 Event A2: my company’s revenue is at least $1M but less than $2M
 Event A3: my company’s revenue is at least $2M
 P(A1) = 0.5; P(A2) = 0.3; P(A3) = 0.2
 Questions:
 P(revenue is at least $1M) = ?
 P(revenue is less than $2M) = ?
 For mutually exclusive events:
4-2f Subjective versus Objective Probabilities
 Objective probabilities are those that can be estimated from long-run

proportions.
 The relative frequency of an event is the proportion of times the event
occurs out of the number of total times.
 However, many business situations cannot be repeated under identical
conditions, so you must use subjective probabilities in these cases.
A subjective probability is one person’s assessment of the likelihood that a
certain event will occur.
4-3 Probability Distribution of a Single Random Variable
 A discrete random variable has only a finite number of possible

values (a continuous random variable has a continuum of possible
values, which will be discussed in normal distribution).
 Probability distribution _ a list of all possible outcomes and their
corresponding probability
 The probability distribution of a discrete random variable X: need to
specify its possible values and their probabilities.
 We assume that there are k possible values, denoted
x1, x2, … , xk.
 The probability of a typical value xi is denoted as either P(X = xi) or p(xi).
Probability Distribution of a Single Random Variable
 Probability distributions must satisfy two criteria:

 The probabilities must be nonnegative.
 They must sum to 1.
 Example: Assume that 4.0 (A), 3.0 (B), and 2.0 (C) are possible grades
that a student can get for BZAN6310 (grade is a random variable)
 The corresponding probabilities are 0.7, 0.2, and 0.1.
 *From the addition rule, the probability P(grade >= 3.0) can be calculated
as? (are events mutually exclusive?)
4-3a Summary Measures of a Probability Distribution
 The mean, often denoted μ, is a weighted sum of the possible values,

weighted by their probabilities:
 Itis also called the expected value of X and denoted E(X).

 To measure the variability in a distribution, we calculate its variance or
standard deviation.
 The variance, denoted by σ2 or Var(X), is a weighted sum of the squared
deviations of the possible values from the mean, where the weights are again
the probabilities.
Summary Measures of a Probability Distribution
 Variance of a probability distribution, σ2, is:
 Variance (computing formula) is:
 A more natural measure of variability is the standard deviation,

denoted by σ or Stdev(X). It is the square root of the variance:
Measures of a Probability Distribution
 Example: Assume that 4.0 (A), 3.0 (B), and 2.0 (C) are possible grades
that a student can get for BZAN6310 (grade is a random variable)
 The corresponding probabilities are 0.7, 0.2, and 0.1.
 What is the expected value of a student's grade?
 What is the variance of a student’s grade?
Example 4.2: Market Return Scenarios for the National Economy
(slide 1 of 2)
 Objective: To compute the mean, variance, and standard deviation of

the probability distribution of the market return for the coming year.
 Solution: Market returns for five economic scenarios are estimated at
23%, 18%, 15%, 9%, and 3%. The probabilities of these outcomes
are estimated at 0.12, 0.40, 0.25, 0.15, and 0.08.
Example 4.2: Market Return Scenarios for the National Economy
(slide 2 of 2)
 Procedure for calculating the summary measures:

1. Calculate the mean return in cell B11 with the formula:
2. To get ready to compute the variance, calculate the squared deviations from the mean
by entering this formula in cell D4:
and copy it down through cell D8.

3. Calculate the variance of the market return in cell B12 with the formula:
OR skip Step 2, and use this simplified formula for variance:
4. Calculate the standard deviation of the market return in cell B13 with the formula:
Probability Distribution of a Single Random Variable
 A discrete random variable has only a finite number of possible

values.
 A continuous random variable has a continuum of possible values.
 Usually a discrete distribution results from a count, whereas a
continuous distribution results from a measurement.
5-2 The Normal Distribution
 The single most important distribution in statistics is the normal

distribution.
 Itis a continuous distribution with symmetric bell-shaped curve.
 Any particular normal distribution is specified by its mean and standard
deviation. (try plot)
 By changing the mean, the normal curve shifts to the right or left.
 By changing the standard deviation, the curve becomes more or less spread out.
 There are really many normal distributions rather than just a single one.
 The normal distribution is a two-parameter family, where the two parameters are the
mean and standard deviation.
5-2a Continuous Distributions and Density Functions
 For continuous distributions, instead of a list of possible values, there is

a continuum of possible values.
 Instead of assigning probabilities to each individual value in the continuum,
we use a density function, which acts like a histogram, for continuous
distributions.
Continuous Distributions and Density Functions
 A density function, usually denoted by f(x), specifies the probability

distribution of a continuous random variable X.
 The higher f(x) is, the more likely x is.
 The total area between the graph of f(x) and the horizontal axis, which represents
the total probability, is equal to 1.
 f(x) is nonnegative for all possible values of X.
 Probabilities are found from a density function as areas under the curve. (Play here)
5-2b The Normal Density
 The normal distribution is a continuous distribution with possible

values ranging over the entire number line—from “minus infinity”
to “plus infinity.”
 Only a relatively small range has much chance of occurring.
 The formula for the normal density function, where μ and σ are
the mean and standard deviation, is as follows:
5-2f Empirical Rules Revisited
 Three empirical rules apply to many data sets.

 About 68% of the data fall within one standard deviation of the mean.
 About 95% fall within two standard deviations of the mean.
 Almost all (99.7%) fall within three standard deviations of the mean.
 For these rules to hold with real data, the distribution of the data must
be at least approximately symmetric and bell-shaped.
5-2c Standardizing: Z-Values
 The standard normal distribution has mean 0 and standard deviation 1, so

it is denoted by N(0,1).
 It is also referred to as the Z distribution.
 To standardize a variable, subtract its mean and then divide the difference
by the standard deviation:
 Standardizing allows measuring variables with different means and/or standard

deviations on a single scale.
 A Z-value is the number of standard deviations to the right or left of the mean.
 If Z is positive, the original value is to the right of the mean.
 If Z is negative, the original value is the left of the mean.
Concept Demonstration
Example 5.1: Standardizing Returns from Mutual Funds
 Objective: To use Excel® to standardize annual returns of various

mutual funds.
 Solution: Data set includes the annual returns of 30 mutual funds.
 Calculate the mean and standard deviation of each annual return and
then calculate the corresponding Z-value.
 OR calculate the Z-values directly, using the STANDARDIZE function.
5-2e Normal Calculations in Excel®
 Two types of calculations are typically made with normal distributions:

finding probabilities and finding percentiles.
 The functions used for normal probability calculations are NORM.DIST and
NORM.S.DIST.
 The main difference between these is that the one with the “S” (for standardized)
applies only to N(0, 1) calculations, whereas NORM.DIST applies to any normal
distribution.
 Percentile calculations that take a probability and return a value are often
called inverse calculations.
 The Excel® functions for these are named NORM.INV and NORM.S.INV.
 Again, the “S” in the second of these indicates that it applies to the standard normal
distribution.
Example 5.2: Normal Calculations in Excel®
 Objective: To calculate probabilities and percentiles for standard

normal and general normal distributions in Excel®.
 Solution: For “less than” probabilities, use NORM.DIST or
NORM.S.DIST directly.
 For “greater than” probabilities, subtract the NORM.DIST or
NORM.S.DIST function from 1.
 For “between” probabilities, subtract the two NORM.DIST or
NORM.S.DIST functions.
 For percentile calculations, use the NORM.INV or NORM.S.INV function
with the specified probability as the first argument.
Example 5.3: Personnel Testing at ZTel
 Objective: To determine test scores that can be used to accept or reject job applicants at
ZTel.
 Solution: Scores of all applicants are approximately normally distributed with mean 525
and standard deviation 55.
 Calculate the percentage of applicants who are automatic accepts or rejects, given the
current standards of 600 for automatic accept and 425 for automatic reject.
 Find new cutoff values that reject 10% and accept 15% of applicants.
Example 5.4: Quality Control at PaperStock
 Objective: To determine the machine settings that result in paper of acceptable quality at
PaperStock Company.
 Solution: A given roll of paper must be rejected if its actual fiber content is less than 19.8 pounds
or greater than 20.3 pounds.
 The variability in fiber content is 0.10 pound when the process is “good,” but increases to 0.15
pound when the machine goes “bad.”
 Calculate the probability that a given roll is rejected, for a setting of μ = 20, when the machine is
“good” and when it is “bad.”
Homework
• Ch.4 Homework (Problems #1(a), p. 148, & #11, p, 155)
• Ch.5 Homework (Problems #1&2, p. 187)
• Exam Review Questions

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BZAN 6310: Quantitative Analysis for Business

Lecture 3. Probability and Normal Distribution

Dr. Jinghui (Jove) Hou

• All are probability statements.

 A probability is a number between 0 and 1 that measures the

 The simplest probability rule involves the complement of an event.

 Events are mutually exclusive if at most one of them can occur—

 Event A1: my company’s revenue is less than $1M

 For mutually exclusive events:

 Objective probabilities are those that can be estimated from long-run

 A discrete random variable has only a finite number of possible

 Probability distributions must satisfy two criteria:

 The mean, often denoted μ, is a weighted sum of the possible values,

 Itis also called the expected value of X and denoted E(X).

 Variance of a probability distribution, σ2, is:

 Variance (computing formula) is:

 A more natural measure of variability is the standard deviation,

 What is the expected value of a student's grade?

 What is the variance of a student’s grade?

 Objective: To compute the mean, variance, and standard deviation of

 Procedure for calculating the summary measures:

and copy it down through cell D8.

OR skip Step 2, and use this simplified formula for variance:

 A discrete random variable has only a finite number of possible

 The single most important distribution in statistics is the normal

 For continuous distributions, instead of a list of possible values, there is

 A density function, usually denoted by f(x), specifies the probability

 The normal distribution is a continuous distribution with possible

 Three empirical rules apply to many data sets.

 The standard normal distribution has mean 0 and standard deviation 1, so

 Standardizing allows measuring variables with different means and/or standard

 Objective: To use Excel® to standardize annual returns of various

 Two types of calculations are typically made with normal distributions:

 Objective: To calculate probabilities and percentiles for standard

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