Exercise Solution 1.10

  1. Measured in USD 1000s, the portfolio’s value has a binomial distribution with parameters n = 20 and p= 0.9. The general formula for the probability function of a binomial distribution is:

    [s1]

    Applying this to our portfolio, we obtain:

    [s2]

    This is graphed in Exhibit s1.

    Exhibit s1: The market value (measured in USD 1000s) of the bond portfolio has a binomial distribution with parameters 20 and 0.9.
  2. The formula for the standard deviation of a binomial random variable X with parameters n and is:

    [s3]

    Measured in USD 1000s, our portfolio’s market value is binomially distributed with parameters 20 and 0.9. Accordingly:

    [s4]

 

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