Introduction to Probability and Statistics

Problem Set 1
PGP 2019 batch Sections E - F
IIM Indore

1. An investor has decided to form a portfolio by putting 25% of his money into McDon-
ald’s stock and 75% into Cisco Systems stock. The investor assumes that the expected
returns will be 8% and 15%, respectively, and that the standard deviations will be 12%
and 22%, respectively.

(a) Find the expected return on the portfolio.

2. The mean and standard deviations of monthly returns of three stocks – American
Express (AXP), JP Morgan Chase (JPM), and General Electric (GE) are given by
(0.014, 0.007, 0.005) and (0.150, 0.110, 0.108) respectively. The correlation matrix for
three stocks are given below.

AXP JPM GE
AXP 1.000 0.581 0.639
JPM 0.581 1.000 0.662
GE 0.639 0.662 1.000

The proportions invested in each stock are as follows – American Express (AXP): 20%,
JP Morgan Chase (JPM): 50%, General Electric (GE): 30%.

(a) Which portfolio would an investor who likes to gamble choose? Explain.
(b) Which portfolio would a risk-averse investor choose? Explain.

3. Every organization maintains some inventory, which is defined as a stock of items. For
example, grocery stores hold inventories of almost all the products they sell. When
the total number of products drops to a specified level, the manager arranges for the
delivery of more products. An automobile repair shop keeps an inventory of a large
number of replacement parts. A school keeps stock of items that it uses regularly, in-
cluding chalk, pens, envelopes, file folders, and paper clips. There are costs associated

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 with inventories. These include the cost of capital, losses (theft and obsolescence), and
warehouse space, as well as maintenance and record keeping. Management scientists
have developed many models to help determine the optimum inventory level that bal-
ances the cost of inventory with the cost of shortages and the cost of making many
small orders. Several of these models are deterministicthat is, they assume that the
demand for the product is constant. However, in most realistic situations, the demand
is a random variable. One commonly applied probabilistic model assumes that the
demand during lead time is a normally distributed random variable. Lead time is de-
fined as the amount of time between when the order is placed and when it is delivered.
The quantity ordered is usually calculated by attempting to minimize the total costs,
including the cost of ordering and the cost of maintaining inventory. Another critical
decision involves the reorder point, which is the level of inventory at which an order
is issued to its supplier. If the reorder point is too low, the company will run out of
product, suffering the loss of sales and potentially customers who will go to a competi-
tor. If the reorder point is too high, the company will be carrying too much inventory,
which costs money to buy and store. In some companies, inventory has a tendency
to walk out the back door or become obsolete. As a result, managers create a safety
stock, which is the extra amount of inventory to reduce the times when the company
has a shortage. They do so by setting a service level, which is the probability that the
company will not experience a shortage.
During the spring, the demand for electric fans at a large home-improvement store is
quite strong. The company tracks inventory using a computer system so that it knows
how many fans are in the inventory at any time. The policy is to order a new shipment
of 250 fans when the inventory level falls to the reorder point, which is 150. However,
this policy has resulted in frequent shortages and thus lost sales because both lead time
and demand are highly variable. The manager would like to reduce the incidence of
shortages so that only 5% of orders will arrive after inventory drops to 0 (resulting in a
shortage). This policy is expressed as a 95% service level. From previous periods, the
company has determined that demand during lead time is normally distributed with a
mean of 200 and a standard deviation of 50. Find the reorder point.

4. Deans and other faculty members in professional schools often monitor how well the
graduates of their programs fare in the job market. Information about the types of jobs
and their salaries may provide useful information about the success of a program. In
the advertisements for a large university, the dean of the School of Business claims that
the average salary of the schools graduates 1 year after graduation is $800 per week,

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 with a standard deviation of $100. A second-year student in the business school who
has just completed his statistics course would like to check whether the claim about
the mean is correct. He does a survey of 25 people who graduated 1 year earlier and
determines their weekly salary. He discovers the sample mean to be $750. To interpret
his finding, he needs to calculate the probability that a sample of 25 graduates would
have a mean of $750 or less when the population mean is $800 and the standard
deviation is $100. After calculating the probability, he needs to draw some conclusion.
Find the desired probability in this case.

5. The restaurant in a large commercial building provides coffee for the occupants in the
building. The restaurateur has determined that the mean number of cups of coffee
consumed in a day by all the occupants is 2.0 with a standard deviation of 0.6. A
new tenant of the building intends to have a total of 125 new employees. What is the
probability that the new employees will consume more than 240 cups per day?

6. In the last election, a state representative received 52% of the votes cast. One year
after the election, the representative organized a survey that asked a random sample of
300 people whether they would vote for him in the next election. If we assume that his
popularity has not changed, what is the probability that more than half of the sample
would vote for him?

7. Operations managers use inventory models to determine the stock level that minimizes
total costs. In Problem 1, we showed how the probabilistic model is used to make the
inventory level decision. One component of that model is the mean demand during
lead time. Lead time refers to the interval between the time an order is made and when
it is delivered. Demand during lead time is a random variable that is often assumed
to be normally distributed. There are several ways to determine mean demand during
lead time, but the simplest is to estimate that quantity from a sample.
The Doll Computer Company makes its own computers and delivers them directly to
customers who order them via the Internet. Doll competes primarily on price and speed
of delivery. To achieve its objective of speed, Doll makes each of its five most popular
computers and transports them to warehouses across the country. The computers are
stored in the warehouses from which it generally takes 1 day to deliver a computer
to the customer. This strategy requires high levels of inventory that add considerably
to the cost. To lower these costs, the operations manager wants to use an inventory
model. He notes that both daily demand and lead time are random variables. He
concludes that demand during lead time is normally distributed, and he needs to know

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 the mean to compute the optimum inventory level. He observes 25 lead time periods
and records the demand during each period. These data are listed here. The manager
would like a 95% confidence interval estimate of the mean demand during lead time.
From long experience, the manager knows that the standard deviation is 75 computers.
235 374 309 499 253
421 361 514 462 369
394 439 348 344 330
261 374 302 466 535
386 316 296 332 334

Table 1: Demand during lead time

8. The image of the Japanese manager is that of a workaholic with little or no leisure time.
In a survey, a random sample of 250 Japanese middle managers was asked how many
hours per week they spent in leisure activities (e.g., sports, movies, television). The
results of the survey were recorded. Assuming that the population standard deviation
is 6 hours, estimate with 90% confidence the mean leisure time per week for all Japanese
middle managers. What do these results tell you?

9. One of the major tools in the promotion mix is advertising. An important decision to
be made by the advertising manager is how to allocate the company’s total advertising
budget among the various competing media types, including television, radio, and
newspapers. Ultimately, the manager wants to know, for example, which television
programs are most watched by potential customers, and how effective it is to sponsor
these programs through advertising. But first the manager must assess the size of the
audience, which involves estimating the amount of exposure potential customers have
to the various media types, such as television.
The sponsors of television shows targeted at the children’s market wanted to know the
amount of time children spend watching television because the types and number of
programs and commercials are greatly influenced by this information. As a result, it
was decided to survey 100 Indian children and ask them to keep track of the number of
hours of television they watch each week. From past experience, it is known that the
population standard deviation of the weekly amount of television watched is σ = 8.0
hours. The television sponsors want an estimate of the amount of television watched
by the average Indian child. A confidence level of 95% is judged to be appropriate.

10. The operations manager of a large production plant would like to estimate the average
amount of time workers take to assemble a new electronic component. After observing

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a number of workers assembling similar devices, she guesses that the standard deviation
is 6 minutes. How large a sample of workers should she take if she wishes to estimate
the mean assembly time to within 20 seconds? Assume that the confidence level is to
be 99%.