MGMT 322

Lecture Notes
1
CHAPTER 3
Probability
Distributions
2
Probability Distribution
• The main motivation of this course is to teach you quantitative
tools that you can use to analyze the degree of future
uncertainty and risks that we have been facing in business
management at an increased rate especially in the era of
globalization.

• And the epidemic that we have been facing with the spread of
CORONA VIRUS in the early months of 2020 has dramatically
increased the degree of uncertainty about the future values of
almost any kind of financial, managerial, economic and social
indicator or variable that we can think of.

3
• The concept of PROBABILITY DISTRIBUTION is one of the
essential and critical tools that statistics has provided to all of
us including pure scientists, engineers, managers, economists,
financial analysts and other social scientists that can be used
to analyze the degree of uncertainty and risks about the future
behavior (or values) of some critical variables that are called
RANDOM VARIABLES.

• Therefore our systematic explanation of this part of our

lectures on probability distributions has to start with the
concept of RANDOM VARIABLES. This is simply because
probability distributions are defined (in a meaningful way)
only in relation to certain variables that are classified as
RANDOM VARIABLES.
4
RANDOM VARIABLES
• A Random Variable is a variable which takes on values
unpredictably as a result of a random process (or experiment)
Note that a process is random for us as long as we have no
power in determining the outcome of that process or
experiment.

• Examples
X: Age of a randomly selected student at our university
Y: The value of stock market Index in Istanbul by the end of
today’s trading session.
Z: Interest rates on a new Treasury Bonds that will be issued by
US GOVERNMENT next month
M: Exchange rate of TL against DOLLAR next Monday
N: The price of petroleum on any randomly selected day.
5
K: Annual profits of Ford Corp. next year
R: Revenues of firm A in North Cyprus next month
D: The demand for apartments in Famagusta next quarter.

• As you can see from these examples almost anything whose value
can not be perfectly known by us are random variables.

• And if we can understand how we can obtain their probability

distributions we may be able to analyze the degree of future
uncertainty and risks that we are facing in relation to them much
better.

• In other words If we can obtain the probability distribution of a

random variable (such as the possible value of the market demand
for our product in any randomly selected month) we can answer
some probabilistic questions about that random variable much
more accurately and hopefully end up increasing our chances of
making optimal production, investment, pricing, marketing 6
inventory, policy, borrowing, lending and political decisions
DISCRETE VERSUS CONTINUOS RANDOM VARIABLES
• Random Variables are classified into 2 general categories ( as
DISCRETE and CONTINUOUS RANDOM VARIABLES) and each
category are further sub-categorized into different types.

• Statistics science has theoretically explained the

characteristics of all different types of discrete and continuous
random variables.

• So in this sense we as management and economics people are

lucky! If we can learn the basic characteristics of certain types
of random variables and their probability distributions (that
are believed to be particularly relevant for business
management, finance and economics) we may be able to
analyze the degree of future uncertainty and risks that we 7
might be facing much more accurately and easily in relation to
such random variables.
• THEREFORE A GIVEN RANDOM VARIABLE IS EITHER DISCRETE RV
or CONTINUOUS RV. How can we tell whether a given RV(such as
X) is a Discrete RV or a Continuous RV?

1. Discrete Random Variable

• If a random variable is allowed to take on only limited number of
possible values (which means any number less than infinity) then
it is a Discrete R.V. (Note that even if a random variable can take
on any one of 500000 different possible values it is still accepted as
a Discrete R.V.)

• Example1: Experiment. Tossing a coin 3 times

X: Number of Heads that may come up.

X is a Discrete RV because there are limited numberof possible

values that it can take on as a result of this experiment. WHY? 8
Because there are only 4 POSSIBLE VALUES THAT X CAN TAKE ON;
(0,1,2,3)
• Example 2: Experiment. Randomly rolling a die.
Y: The number that comes up.

ONE OF THE MOST IMPORTANT TYPES OF DISCRETE RV THAT IS

PARTICULARLY RELEVANT FOR MANAGEMENT APPLICATIONS IS
THE BINOMIAL RANDOM VARIABLES. (Later on we will attempt
to show and explain not only the characteristics of them but
how we can obtain and apply their probability distributions to
management and economics related cases.)

9
2. Continuous Random Variable
• If a random variable is allowed to take on any one of the
infinite number of possible values that lie over a certain range
(between some minimum and maximum) then that RV is
assumed to be a continuous RV.

• Note that in mathematics theoretically there are infinite

(infinity) number of possible values between any 2 numbers.

• Therefore if a RV is allowed to take on any value between any

2 numbers (such as between 23 and 41) without any limitation
then that RV is accepted as a continuous RV.

10
• Ex1

X: Height of a randomly selected student in the class:

Suppose that the only information that we have about the

heights of students in this class is the fact that the minimum
height is 155cm and maximum height is 186 cm:
Xmin=155 cm
Xmax=186 cm

There are infinite number of possible values between these 2

values.. Therefore, X (height) is considered to be a continuous
random variable.

11
• One of the most important types of continuous RV (whose
probability distribution is called NORMAL PROBABILITY
DISTRIBUTION) is the NORMAL RANDOM VARIABLES.

• Usually we assume that many of the continuous random

variables that we face in the real world of management,
finance and economics are behaving (if not perfectly
approximately) like Normal Random Variables.

12
• MOST OF THE TIME ECONOMISTS AND FINANCIAL ANALYSTS FIND
CONVENIENT TO ASSUME THAT MANY OF THE FINANCIAL RV ARE
CONTINUOUS RANDOM VARIABLES.

• SOME EXAMPLES OF SUCH RV INCLUDE EXCHANGE RATES, STOCK

PRICES, PROFITS, REVENUES, PRICE OF GOLD,PRICE OF
PETROLEUM, INFLATION RATE, INTEREST RATES, GDP GROWTH
RATE, PRICES OF ANY KIND OF INPUTS OR COMMODITIES AND etc.

• For example the value of the exchange rate of TL against US

DOLLAR (in any randomly selected moment) may be assumed to
take on any value over an interval ranging from some minimum to
some maximum.

• And many times ( if not always) we believe that these RV are

behaving like Normal Random Variables and therefore their 13
probabilistic behavior can be analyzed using their probability
distribution known as Normal Distribution.
• Earlier we stated that if we can obtain the probability
distribution of random variables such as the ones mentioned
above we can analyze probabilistic questions about them
much more accurately and therefore improve our prospects in
making optimal (profit maximizing and/or cost minimizing)
decisions.

• Given this we now focus on understanding what we mean by

the concept of PROBABILITY DISTRIBUTION and more
importantly how we can obtain probability distribution of a
RV(X).

14
PROBABILITY DISTRIBUTION OF A RANDOM VARIABLE
• It is simply the listing of probabilities that correspond to each
possible value of that random variable. NOTE. It is critical to
remember that the sum of all probability values in any prob.
distribution always add up to 1.(100%).

• Therefore to obtain the probability distribution of a random

variable (X) we need to carry out the following 2 steps
successfully.

• Two Steps to Obtain the Probability Distribution of X:

Step 1: Obtain all the possible values that X can take on.
Step2: Obtain the probability of the occurrence of each possible
value of X.
15
• Then, present the results in a form of a Table or a Graph.
• Ex1: Suppose that the numerical distribution of students in
terms age in a class is given below. And we want to obtain the
probability distribution of RV X defined as follows:
X: Age of a randomly selected student

Number of
Age
Students
20 1
21 5
22 7
23 4
24 3
26 1
Total 21

16
Step 1: Possible X values:

X1 20

X2 21

X3 22

X3 23

X5 24

X6 26

17
Step 2: Obtain the probability of each possible X values (And
then present the results in the form of a Table as below or in
the form of a graph).

x P(x)
20 1/21
21 5/21
22 7/21
23 4/21
24 3/21
26 1/21

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• Ex2: Experiment : Randomly tossing a coin 3 times

X: Number Of HEADS that may come up.

Step1: There are 4 possible values that X can take on. (0,1,2,3)
Step2: Probability of each possible value can be obtained using
the classical approach.

NOTE: OBTAIN THE PROB OF OCCURRENCE OF EACH POSSIBLE X

VALUE YOURSELF BY SPECIFYING THE SAMPLE SPACE OF THIS
EXPERIMENT AND THEN USING THE CLASSICAL APPROACH

19
THE PROBABILITY DISTRIBUTION OF X

X P(X)
0 1/8
1 3/8
2 3/8
3 1/8

20
EXPECTED VALUE OF A RANDOM VARIABLE
• This is a very important concept and statistical tool for
business managers, economists and policy makers. You hear
regularly on the news, experts talking about the EXPECTED
VALUES OF PROFITS, REVENUES, SALES, EXCHANGE RATE OF
DOLLAR AGAINST EURO, INFLATION, GDP GROWTH, INTEREST
RATES, PETROLEUM PRICE and etc.

• Therefore we need to understand first theoretically what

EXPECTED VALUE OF A RV (X) means in Statistics and how we
can calculate it.

• And then we can understand how to interpret the real world

meaning of the calculated EXPECTED VALUES OF certain
BUSINESS RELATED RV such as DEMAND (or SALES) and use
them in making different managerial decisions: such as 21
production, input ordering or investment decisions.
• In statistics EXPECTED VALUE OF A RV (X)’is denoted as E(X) .

• It is simply a weighted average of all possible values of X. The

weight of each possible X value is the probability of
occurrence of that X value. And therefore those X values which
are relatively more likely to occur are reflected relatively more
heavily in the expected value of X.

• But be careful; Expected Value of X does not automatically tell

us the value that is most likely to occur as a result of the given
experiment. This is one common misconception about the
meaning of expected value particularly when some people use
this concept in the real world. Remember in STATISTICS it is
simply a weighted average of all possible values.

22
E(X) for a Discrete Random Variable

• E(X) = ∑P(Xi)Xi
P(Xi) = Probability of occurrence of the ith value

• Using the Ex 1 that we did earlier (above) about the

probability distribution of the AGE OF A RANDOMLY SELECTED
STUDENT (X) we can use the formula for E(X) to calculate
EXPECTED AGE OF A RANDOMLY SELECTED STUDENT.:
E(X) = (20)(1/21) + (21)(5/21) + (22)(7/21) + (23)(4/21) +
(24)(3/21) + (26)(1/21)
= 0.95 + 5 + 7.33 + 4.38 + 3.43 + 1.24
≈ 22 years
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E(X) for a Continuous Random Variable

• E(x) = ∫P(x)xdx
(Where P(x) is the prob. density function of x)

• As you can see obtaining Expected Values of Continuous RVs

is relatively more challenging and requires a good background
in calculus and mathematical statistics. And this is beyond the
scope of our class.

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• Example 2
Suppose that the numerical distribution of all the countries in
the world in terms of their growth rates of real GDP in 2019 is
given below:
Growth Rate Number of Countries
8% 20
6% 30
4% 50
2% 100
Total 200

What is the Expected growth rate of a randomly selected

country (in the world) in 2019?

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Solution:
E(Growth Rate) = (0.08)(20/200) + (0.06)(30/200) + (0.04)
(50/200) + (0.02)(100/200)
= 0.008 + 0.009 + 0.01 + 0.01
= 0.037 = 3.7%

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• Example 3
Suppose that we have 500 faculty members at EMU. 100 of
these are full Professors, 150 of them are Assoc. Professors and
the rest 250 of them are Assistant Professors. The monthly
salary of each group is $4000, $3000 and $2000 respectively.

a)Obtain the probability distribution of the salary of a randomly

selected faculty member at EMU.

b)What is the expected value of the salary of a randomly

selected faculty member at EMU.?

27
Solution:
X: Salary of a randomly selected faculty member.

a) X P(X)
4000 P(4000)= 100/500=0.20
3000 P(3000)=150/500= ~0.30
2000 P(2000)=250/500=0.50

b) E(X)= E(Salary)
E(X)= ∑P(Xi)Xi = (0.2*4000) + (0.3*3000)+(0.5*2000)
E(X)= 800 +900 + 1000= $2,700
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• SELF STUDY

SUPPOSE THAT IN THE PAST 100 MONTHS MONTHLY SALES OF

APARTMENTS IN FAMAGUSTA HAVE BEEN 40 units (in 20 of the
past 100 months), 50 units (in 45 of the past 100 months) and
60 units(in 35 of the past 100 months). What is the EXPECTED
NUMBER OF APT. SALES IN ANY RANDOMLY SELECTED MONTH
IN THE FUTURE?

(ANSWER: E(X)=51.5)

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Binomial Probability Distribution
• It is the probability distribution of a type of discrete random
variable called Binomial Random Variable.

• Binomial R.V. takes on values as a result of Bernoulli Process.

And therefore it is a type of Discrete Probability Distribution.

• We can understand whether or not a given random variable is

a Binomial R.V by checking out the characteristics of the
process (or the experiment) as a result of which it takes on
values.

• If the following 4 characteristics exist then we realize that the

process is a Bernoulli type of process (or experiment) and
therefore the RV in question is a Binomial RV. 30
Characteristics of a Bernoulli Type Process
i. It’s made up of fixed number of trials of the same activity.
ii. Each trial has two outcomes only. (Success or Failure)
iii. The probability of success on each trial remains fixed over all
trials.
iv. Each trial is statistically independent of each other.

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• Binomial Formula:

P(r) =

n: Number of trials.
r: Number of success outcomes.
p: Probability of success outcomes.
q = (1 – p): Probability of failure.

P(r) = Probability of getting exactly r (successes) out of n trials.

NOTE; n!=n*(n-1)*(n-2)*…..*1 (Ex. 3!=3*2*1=6) AND : 0!=1

32
• Some of the Questions that can be answered using Binomial
Formula:

Q1: Obtain the probability distribution of a Binomial Random

Variable X
Q2: What is the probability of getting at least r* successes out
on n trials; P(r ≥ r*)
Q3: What is the probability of getting at most r* successes out
of n trials; P(r≤ r*)
Q4: What is the probability of getting exactly r* successes; P(r*)
Q5: Obtain E(X) or any other variable based on probability
distribution of X. i.e. E(Y).

33
• General Answers:

Q1:Using the Binomial Formula, find the probability distribution

of X
X P(X)
X1 P(X1)
X2 P(X2)
X3 P(X3)
Xn P(Xn)

Q2: P(r ≥ r*) = P(r*) + P(r* + 1) + ……P(n)

Q3: P(r≤ r*) = P(0) + P(1) + …….P(r*)
Q4: Use the formula to get the answer.

34
• Example 1
Suppose that we toss a coin 4 times.

Q1. What is the probability of getting exactly 2 Heads?

Q2. What is the probability of getting at least 3 Heads?
Q3. What is the probability of getting at most 3 Heads?
Q4. Using the binomial formula obtain the binomial probability
distribution of the possible number of tails may come up.

35
Solution:
Q1. n = 4 p = 1/2 ( prob of getting a Head) q = 1/2 (prob of
getting a Tail)
4!
P(2) = (1/2)2(1/2)4-2 = 0.375
2!(4 - 2)!

Q2. P(r≥3) = P(3) + P(4)

4!
P(3) = (1/2)3(1/2)4-3 = 0.25
3!(4 - 3)!

4!
P(4) = (1/2)4(1/2)4-4 = 0.0625
4!(4 - 4)!

36
P(r≥3) = 0.3125
Q3. P(r ≤3) = P(0) + P(1) + P(2) + P(3)
4!
P(0) = (1/2)0(1/2)4-0 = 0.0625
0!(4 - 0)!

4!
P(1) = (1/2)1(1/2)4-1 = 0.25
1!(4 - 1)!

P(r ≤3) = 0.9375

37
Q4. p: probability of getting Tail
q: probability of getting Head.

X= Number of TAILS that comes (Note that X is a Binomial R.V!)

There are 5 possible values of X; (0, 1, 2, 3, 4,)

Using the binomial formula we can obtain the prob. of

occurrence of possible X value. The possible X value and their
corresponding probabilities are reported below:.;

X=0 X=1 X=2 X=3 X=4

P(0) = 1/16 P(1) = 4/16 P(2) = 6/16 38

P(3) = 4/16 P(4) = 1/16
• Example 2
Suppose there are 2 outcomes for inflation in Turkey for each year:
High or Low. If inflation rate is greater than 100%, inflation is high. If it
is less than or equal to 100%, inflation is low for that year. Sabanci
Corporation makes $50 million of positive profits for each year of high
inflation and loses $20 million for each year of low inflation.
Economists estimated that the probability of high inflation is 80% for
each of the next 4 years.

a. What is the probability of getting exactly 2 years of high inflation

(HI) in the next 4 years?
b. What is the probability of getting at least 3 years of HI over the next
4 years?
c. What is the probability of getting at most 3 years of LI?
d. What is the expected total profits of Sabanci over the next 4 years?

39
a. What is the probability of getting exactly 2 years of high
inflation (HI) in the next 4 years?
n= 4 r= 2 p=0.8 q=0.2

P (2) = (4! / 2! (4-2)!) *[(0.8)2 * (0.2)4-2] = 0.1536

b. What is the probability of getting at least 3 years of HI over

the next 4 years?

P (r ≥ 3) = P (3) + P (4) = 0.4096 + 0.4096 = 0.8192

P (3) =( 4! / 3! (4-3)!) * [(0.8)3 * (0.2)1] = 0.4096

P (4) = (4! / 4! (4-4)!) * [(0.8)4 * (0.2)0] = 0.4096

40
c. What is the probability of getting at most 3 years of LI?

p = 0.2 (Now we take prob. of success as prob. of low inflation

(LI) for each year)
q = 0.8

P (r ≤ 3) = P (0) + P (1) + P (2) +P (3) = 0.4096 + 0.4096 + 0.1536

+ 0.0256 = 0.9984

P (0) = 0.4096
P (1) = 0.4096
P (2) = 0.1536
P (3) = 0.0256
41
d. What is the expected total profits of Sabanci over the next 4
years?

p = 0.8
q = 0.2

What is critical here is to realize that total profits over the next 4 years
is a discrete R.V which is determined by the number of years of HI and
LI over the next 4 years. And if X represents the number of years of HI
then for each possible value of X we have a corresponding possible
value of TOTAL PROFITS (Y) OVER THE NEXT 4 YEARS.

42
X Y(TOTAL PROFITS) P(Y) =P (X)
X1=4 All 4 years of HI P (200 ) = P (4)
4*50 = 200 M. (Y1)
X2=3 3 years of HI and 1 year of LI [(3X50) – (1*20)] = 130 P (130) = P (3)
M.(Y2)
X3=2 2 years of HI and 2 years of LI P (60) = P (2)
(2*50) – (2*20) = 60M. (Y3)
X4=1 1 year of HI and 3 years LI P (-10) = P (1)
(1*50) – (3* 20) = -10M. (Y4)
X5=0 0 year of HI and 4 years of LI P (-80) = P (0)
(0*50) – (4*20) = -80M. (Y5)

E(Total Profits) = (-80 * 0.0016) + (-10 * 0.0256) + (60 *

0.1536) + (130 * 0.4096) + (200 * 0.4096) = 144  $144 Mn

43
• Example 3
Prof. TT has put $2 on each of the 3 horses running three
different races in Istanbul Horse Racing center. He feels that each
of the bets he has made has a 0.2 probability of winning. A
winning ticket on any of the three horses will earn Prof. TT $40.
Assuming a Bernoulli process, answer the following questions:

a. What is the probability of at least 2 horses (on which Prof. TT

has bet) winning?
b. What is the Expected Profits from all the three horses?
c. What is the probability of at most 1 out of the three horses
(on which Prof. TT has bet) winning?
d. What is the probability distribution of his possible profits from
all the three races?
44
 Solution:
n= 3 p = 0.2 ( prob of winning on each race)
q = 1- 0.2 = 0.8 ( prob. of losing on each race)
X= Number of horses (on which TT has bet) winning
Y= Profits

3!
P(0) = 0.20 0.830 = 0.512
0!3  0 !
3!
P(1) = 0.21 0.831 = 0.384
1!3  1!

3!
0.22 0.832
2!3  2 !
P(2) = = 0.096

3!
P(3) = 0.23 0.833 = 0.008
3!3  3! 45
 PROB. DISTRIBUTION OF X (number of horses winning) and Y
(Profits)

X Profits (Y) P(X) (=P(Y))

0 (0*40) – 6 = -6 0.512
1 (1*40) – 6 = 34 0.384
2 (2*40) – 6 = 74 0.096
3 (3*40) – 6 = 114 0.008

a. P(r ≥ 2) = P(2) + P(3) = 0.096 + 0.008 = 0.104

b. E(X) = -6(0.512) + 34(0.384) + 74(0.096) + 114(0.008)

= -3.072 + 13.056 + 7.104 + 0.912 = $18

c. P(r ≤ 1) = P(0) + P(1) = 0.512 + 0.384 = 0.896

Profits (Π )= Revenues- Cost
$2*3= $6 (Cost of a ticket)

i.e.: If X=0 , Y=Π= - 6 46

X= 1, Y= (1*$40) – 6 = $34
X= 2, Y= (2*$40) – 6 = $74
d. . X Profit(Y) P(Y)=P(X)
0 -6 0.512
1 34 0.384
2 74 0.096
3 114 0.008
Total 1

47
• Example 4
Suppose that the inflationary process in Turkey is a Bernoulli
process over the next 5 years. The probability of inflation rate to
be high (meaning that it exceeds 100%) for each year over the
next 5 years is estimated to be ¾. Note that the low inflation
corresponds to the case when the annual inflation rate is less
than or equal to 100%. If the company XYZ earns approximately
$10 million in a typical year of high inflation, and loses $5 million
in a typical year of low inflation, what is the expected profit of
XYZ for the next 5 years?

48
Solution:
n = 5 years
X: Number of Years Of High Inflation (HI)
Note that for each possible value of X we have a corresponding
possible value of TOTAL PROFITS(Y) over the next 5 years

Y: TOTAL PROFITS OVER THE NEXT 5 YEARS

Therefore to obtain the Prob. distribution of Y we need to obtain
the Prob. Distribution of X. Using Binomial Formula we obtain
the following;

49
 X Y( Profits ) P(X) (= P(Y))
0 (0*10) – (5*5) = -25 0.0010
1 (1*10) – (4*5) = -10 0.0146
2 (2*10) – (3*5) = 5 0.0878
3 (3*10) – (2*5) = 20 0.2637
4 (4*10) – (1*5) = 35 0.3955
5 (5*10) – (0*5) = 50 0.2373

E(profits) = (-25) * (0.0010) + (-10) * (0.0146) +

(5) * (0.0878) + (20)*(0.2637) + (35)*(0.3955) + (50)*(0.2373)
= $31.250 Million

50
Normal Probability Distribution
• This is a type of continuous probability distribution and its
range extends from negative infinity to positive infinity.

• As stated before this is an extremely important statistical tool

not only for engineers but also for us in terms of management,
economics and finance. It is used in a variety of cases involving
risk analysis in financial markets, feasibility analysis of
investment projects, production and strategic planning,
macroeconomic policy making and managerial economic
analysis at large and etc.

51
Characteristics of the normal probability curve

1. Bell shaped probability curve.

2. It has a single peak
3. Average of the population called Mean (μ) lies at the center and the
distribution is symmetrical at the vertical line erected at μ.
4. Two tails extend indefinitely to positive and negative infinity.
52
Two Parameters: Population Mean (μ) & Standard
Deviation (σ)
• In order to describe any normal random variable we need to
obtain the MEAN and the STANDARD DEVIATION of the data
making up the population of that R.V.

μ: Located in the center of the population and it shows us the

central tendency of the data. It is the average of the data.

σ: It gives information about relative spread of data around the

mean.

53
WE USE THE FOLLOWING FORMULAS TO CALCULATE THE
MEAN AND STD. DEVIATION OF THE GIVEN RV (X). AND
AFTER WE OBTAIN THESE 2 PARAMETERS WE SAY THAT X IS
NORMALLY DISTRIBUTED WITH THE CORRESPONDING MEAN
VALUE AND STD. DEVIATION.

54
Application of Normal Distribution

• To understand how to use Normal Prob. Distribution as a tool

to carry out probabilistic analysis of the behavior of business
related real world variables (that are assumed to be behaving
like normal random variables) we need to learn how to use a
TABLE known as STANDARD NORMAL TABLE which gives us
prob. values (percentages) for specific intervals corresponding
to each possible value of one specific Normal RV known as
STANDARD NORMAL RANDOM VARIABLE (z).

• Z is called Standard Normal RV because it is distributed with a

MEAN VALUE OF 0 and STD. DEVIATION OF 1

• The probability values (or percentages) given in this Table are

calculated using the following 3 FACTS that are valid for ALL 55
NORMAL RANDOM VARIABLES AND THEIR DISTRIBUTIONS.
 3 Mathematical Facts about Normal Distribution

• Approximately 68% of the population lies in the interval ranging 1σ

below the µ to 1σ above the µ.

• 95% of the population lies in an interval ranging 2σ below the µ to

2σ above the µ.

• 99% of the population lies in an interval ranging 3σ below the µ to

3σ above the µ.

X~N (50, 5)

µ = Σx/ N = $ 50, σ = 5

56
HOW CAN WE USE Z TABLE?

• Z ~ N (0,1)

• For any z value such as z=2, Z TABLE gives us Percentage of z values

that are less than (or equal to) 2. And this means PROB. OF ANY
RANDOMLY SELECTED Z VALUE TO BE LESS THAN (or equal to) 2
P(z<2) IS GIVEN BY THAT PERCENTAGE. FROM THE Z TABLE WE SEE
THAT THAT PERCENTAGE IS 0.97725.

• NOTE that due to symmetricity characteristic of normal distribution

this 0.97725 automatically gives us the PERCENTAGE OF Z
POPULATION THAT ARE GREATER THAN (or equal) TO -2 P(z>-2).
AND THIS MEANS PROB. OF A RANDOMLY SELECTED Z VALUE (FROM
A POPULATION OF Z VALUES) TO BE GREATER THAN (or equal to) 2 ıs
0.97725. AND THAT IS WHY Z TABLE DOES NOT REPORT SEPERATELY
P VALUES FOR NEGATIVE Z VALUES BECAUSE WE CAN OBTAIN SUCH
P VALUES USING THIS SYMETRICITY CHARACTERISTIC. 57
VERY IMPORTANT NOTE:

• HOW TO USE Z TABLE TO ANSWER PROBABILITY QUESTIONS

ABOUT ANY NORMAL RANDOM VARIABLE (X)?

• To be able to do this we need to CONVERT (or transform) any

given critical X VALUE into its corresponding Z VALUE. THE
FORMULA THAT ALLOWS US TO DO THIS IS GIVEN BY:

• Z= (X – Mean of X) / Std. Deviation of X

58
• Example 1:
Suppose that the stock price of Corp. X (s) is distributed
normally with a µ of 100 TL and σ of 10 TL?

What is the probability of s to be more than 120 TL in any day?

What is the probability of s to be less than 90 TL in any day?

59
Solution:
a.

z = (120 – 100)/ 10 = 2

P (s > 120) = P (z > 2) = 1 – P (z < 2) = 1 – 0.97725 = 0.02275

60
b.

z = 90- 100 / 10 = - 1

P (s < 90) = P (z <-1) = 1- P (z >- 1) =1-P(z<1)= 1 – 0.84134

= 0.15866

61
• Example 2
Prof. TT believes that the annual profit of Turkish banks is a
normal random variable with a mean of $600,000 and a
standard deviation of $100,000. Prof. TT is currently analyzing
those banks whose annual profit volume lies between $500,000
and $650,000.

a. If total number of banks is 270, what is the approximate

number of bank that Prof.TT will analyze?

b. If Prof. TT randomly selects a bank to analyze, what is the

probability that this bank will have an annual profit volume of
more than $400,000?

62
 Solution:

µ = $600,000
σ = $100,000
X Y

500,000 600,000 650,000 $(PROFITS)

a. P(500,000 ≤ $ ≤ 650,000) =P (z1 ≤ z ≤ z2)
z1 = 500,000 – 600,000 / 100,000 = -1
z2 = 650,000 – 600,000 / 100,000 = 0.5

Area X = P(z ≤ +1) – 0.5 = 0.84134 – 0.5 = 0.34134

(NOTE; P(z>-1)=P(z<+1))
Area Y = P(z ≤ 0.5) – 0.5 = 0.69146 – 0.5 = 0.19146
63
Area X + Area Y = 0.34134 + 0.19146 = 0.5328

The Approximate number of Banks = 270*0.5328 = 143.856 ≈ 144

b. P($ > 400,000)

400,000 600,000 $ (PROFITS)

Z* = 400,000 – 600,000 / 100,000 = -200,000 / 100,000 = -2

P (Z>-2) = P (Z < +2) = 0.97725

64
• Example 3
A financial analyst computed the return on stockholder’s equity
for all the companies listed on the New York Stock Exchange. She
found that the mean of this distribution was 10%, with a
standard deviation of 5%. She is interested in examining further
those companies whose return on stockholders’ equity is
between 16% and 22%. Of the approximately 1,300 companies
listed on the exchange, how many are of interest to her?

65
Solution:
µ = 10%
σ = 5%
n = 1,300 (Total Population)

10% 16% 22% r

66
First we need to find the PERCENTAGE OF THE POPULATION OF COMPANIES
whose rate of return is between 16% and 22%. To do this we need to convert
these r values into their respective z values as follows and then use the Z
TABLE to get the % of z values that lie between these 2 z values:

Z1 = 16% - 10% / 5% = 1.2 (z value that corresponds to 16%)

Z2 = 22% - 10% / 5% = 2.4 (z value that corresponds to 22%)

P(1.2 ≤ Z ≤ 2.4)

For: Z2 = P(Z ≤ 2.4) = 0.99180

Z1 = P( Z ≤ 1.2) = 0.88493

0.99180 – 0.88493 gives us the % of the population of companies whose

returns are between 22% and 16%. And since the population of companies is
1300.

67
Number of Companies of interest to her = (0.99180 – 0.88493) * 1,300 =
0.10687 * 1300 = 139
68