MS&E 147 Lecture Notes - Lecture 3: Random Variable, Cash Flow, Weighted Arithmetic Mean

• School: Stanford University
• Department: MS&E - Mgmt Science & Engineering
• Course: MS&E 147
• Professor: Anat Admati

Document Summary

Announcements: friday sections same time and place as class. In finance: price of asset next year, stock price of google tomorrow, oil price after some period of time. Uncertainty of outcomes: quantified by random variables that has different values, each with a different probability. Random variable x tells us number of heads in some amount of coin flips. Toss coin 10 times: x can be 0 heads, 1 head, 10 heads. Probability in random variables captures the uncertainty in financial assets" values. These probabilities are predicted based on statistical analysis and subjective assessments (previous data) Sum of all possible outcomes weighted by probabilities (probability weighted average) Example: 1$ for each head, 0$ for each tail. Expected value of x (random variable representing money after one toss): E[x] = ( ) + 0$ ( ) = 0. 75 $ Market price of security is present value of expected future cash flow discounted at appropriate discount rate.