Fixed Income Mathematics
Offering explanations, exercises, and examples without demanding sophisticated mathematics, this self-teaching book will serve as a gateway to financial mathematics and to increased competence in business analysis.
TABLE OF CONTENTS Fixed Income Mathematics
Chapter 18: Probability and Some Applications to Finance
If you do much work in finance, you should understand at least the rudiments of probability and statistics, and how they can be used in the financial field. Probability has been applied in the actuarial field for many years. However, only relatively recently have the ideas of probability been applied extensively in finance. They can also be applied in project analysis. This chapter and Chapter 20 on variable cash flows show you how you can use these concepts in analysis in these fields.
This is not the place for a complete introduction to probability and statistics. Many fine books exist on these subjects. We present a simple overview of elementary probability concepts, the ideas of discrete and continuous distributions, and some statistical measures, and then we explain how you might use some of these concepts.
ELEMENTARY CONCEPTS IN PROBABILITY: A REVIEW
Probability, in the sense we will use it here, means a measure of the chance of an event, or a set of events, occurring. Probabilities can range from 0 to 1, inclusive. A probability of 0 means that the event is impossible; a probability of 1 means the event is certain. Thus, if p is a probability, then
EXAMPLES OF PROBABILITIES
Some examples of probabilities familiar to almost everybody. For instance, if you flip a fair coin, there is a 50% chance it will land heads and a 50% chance it will land tails. This is, in fact, the definition of a fair coin. Then, for a...
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