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Hi Sir,
Good morningSorry Sir, can you explain me about probability of negative cash balance and probability of exceeding the overdraft limit.
I have been trying to have explaination of it using the text book, but I do not find clearly what it is all about.1) For example using the data in question one, june 2010 exam, for period one I can state that both probability of negative cash balance and for exceeding the overdraft limit is 0,30 or 30%. But I do not understand clearly why.
2) In period two, the probability of negative cash balance is 0,02+0,12+0,06 = 20%. Here I do understand, because is where we have negative expected values (30), (660) and (690). I´m alright?
But I do not understand why the probability of exceeding the overdraft limit in that period is 18% (0,12+0,06). Can you explain me?3) Calculation of the value to guard against exceeding overdraft limit.
Why we have to use only the last negative value?
For example in period one is $2500 – $2000 and the result is $500. Here is quit clear, but when we have more than one negative value, why we still using only one?
For exemple in period two is $11500 – $2000 and the result is $9500.Sorry for that, I can not find the explaination of it in my F9 text book.
Best Regards
ET1) In period 1, there is a 0.3 probability that there will be a cash outflow of 2000. That means that out of 10 times we would expect 3 of the times that the cash outflow would be 2000. If it is 2000, then because we start the period with a negative balance of 500 we would end the period with a negative balance of 2500. Also we would be exceeding the overdraft limit of $2. This only happens if the outflow is 2000 (the other possible flows result in a positive closing balance). Since there is a 0.3 probability of the outflow being 2000, there is a 0.3 probability of having a negative closing balance, and of exceeding the overdraft limit.
2) In period 2, you are correct about the negative cash balance.
The overdraft limit is $2000 (per the question) and so it is only exceeded when the overdraft at the end is either 5,500 or 11,500. The probability of 5,500 is 0.12 and of 11,500 is 0.06 – total is 0.183) In period 2, there is always the possibility of ending up with an overdraft of 11500 and if we want to be certain of never breaking the limit of 2000 we need an extra 9500. If the extra was lower then maybe we would not be breaking the limit most of the time, but there is still the chance of having outflows of 2500 in period 1 and 9000 in period 2 (total 11500) in which case we would break the limit. By having an extra 9000 we would never ever break the limit.
It is not something you would expect to be in your textbook because there is no special technique involved. The problem is understanding the wording of the question and understanding what is happening – that you can only get by practice. Next time the examiner has something similar the wording will probably be completely different.
This question is so , the students would have been very Opissed after this exam.Out of all the main areas of f9 , examiner ended up asking a complicated question about EV.
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