Quiz Chapter 6
Time: 150 Minutes
Question 1:
1.1. Henry is participating in a week-long dart-throwing challenge as part of a performance study
in cognitive-motor optimization. Each day for 7 consecutive days, he throws a dart 10 times.
Each throw is independent.
The game uses the following success definitions:
The probability that a single throw hits the dartboard is P(Hit)=0.60
The probability that a single throw hits the bullseye is P(Bullseye)=0.45
(Note: every bullseye is also considered a hit)
A "perfect throw day" is defined as any day where Henry hits the bullseye more than 4 times out
of 10 throws. What is the probability that Henry achieves at least 3 “perfect throw days”
within the 7-day period? (5 points).
1.2. When messages are sent over a network, there is a chance that the bits will be corrupted. The
Hamming Code method, an error-correcting code system, allows for a 4-bit code to be encoded
as 7 bits, with the advantage that if either 0 or 1 bit is corrupted, then the message can be
perfectly reconstructed. Historically, the probability of any bit being lost in space is 0.1. How
does reliability change when the Hamming Code method is used? (5 points).
Question 2:
2.1. A gambling book recommends the following strategy for the game of roulette. It
recommends that the gambler bet 1 on red. If red appears (which has a probability 18/38 of
occurring), then the gambler should take his profit of 1 and quit. If the gambler loses this bet, he
should then make two subsequent bets of size 1 each, and then quit. Let X denote the gambler’s
winnings.
(a) Find the expected return of this player. (5 points).
(b) Draw the PDF and CDF of X. (5 points).
2.2. A lawyer must decide whether to charge a fixed fee of $5,000 or take a contingency fee of
$25,000 if she wins the case (and 0 if she loses). She estimates that her probability of winning is
0.30. Determine the mean and standard deviation of her fee if
(a) She takes the fixed fee. (5 points).
(b) She takes the contingency fee. (5 points).
Question 3: A leveraged firm has $10,000 of capital available to invest today. It faces two
mutually exclusive investment projects and must choose only one. The economy is assumed to
evolve under two possible states over the next two years:
Boom, with probability P(Boom) = 0.44
Recession, with probability P(Recession) = 0.56
The firm is obligated to repay $8,500 in two years, regardless of which project it undertakes.
Suppose there is no tax. The available projects differ in risk and return profiles as follows:
Project A – Low-Risk
Initial Investment: $5,000
Cash flow in 2 years:
o $6,000 if a Boom occurs
o $3,500 if a Recession occurs
Project B – High-Risk
Initial Investment: $6,000
Cash flow in 2 years:
o $13,500 if a Boom occurs
o $3,200 if a Recession occurs
As a shareholder, which project would you choose? Justify your answer using quantitative
reasoning. (20 points). Hint: The cash flow distributed to shareholders is the cash flow that
excludes the liability of debt.
Question 4: As part of your internship with the Risk & Pricing Analytics Division at Altura
Markets, you are evaluating the structure of simplified betting instruments offered in niche sports
markets. You are given the odds table for a local exhibition three-player tennis round-robin
challenge, where one and only one winner will be declared.
The outcomes and odds offered by the bookmaker (in fractional format) for the backers are as
follows:
Outcome (Winner) Player A (1) Player B (2) Player C (3)
Offered Odds 1:1 2:1 5:1
The bettor may place any amount of money on any outcome. Assume all bets are settled at the
stated odds, and the odds remain fixed until the match is resolved. Calculate the expected return
of the bettor in each outcome, and what can you interpret from your calculation (whether the
betting is fair or not)? (20 points). Hint 1: A bet is fair if the expected return for all players is
equal to zero. Hint 2: The odds: o i :1 mean your return is o i for every $1 you bet in outcome i (if
outcome i occurs).
Question 5: FinQuant Capital is developing an algorithmic system to identify arbitrage
opportunities in global sports betting markets. You are tasked with analyzing a betting odds table
issued by a major sportsbook for an exhibition tennis final featuring four star players: Novak,
Carlos, Jannik, and Medvedev.
The bookmaker offers the following fractional odds (o:1) to back each player (i.e., to bet in favor
of that player winning the match):
(a) Outcome (Winner) Novak (1) Carlos (2) Jannik (3) Medvedev (4)
Offered Odds 2:1 3:1 4:1 5:1
Determine whether the betting setup is fair for each outcome? (10 points)
(b) Assuming you are a quantitative investor acting as a backer, construct a sure winning
betting strategy, such that the return is strictly positive and equal regardless of which outcome
occurs. (20 points). Hint 1: A bet is fair if the expected return for all players is equal to zero.
Hint 2: The odds: o i :1 mean your return is o i for every $1 you bet in outcome i (if outcome i
occurs).