# Probability question

There is a 45% probability of rising interest rates with no inflation and a 45+65%=110% probability of rising interest rates with inflation. What is the probability of inflation when interest rates are rising, given a 60% chance of inflation?

This somehow doesn’t look straightforward!

Could you explain your answer?

Dreary

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Please look at the Errata. I remember this was a Stalla question for which I had raised the errata.

Revised question:

1/5/07

2

101

Question #9 should read as: “There is a 45% probability of rising interest rates with no inflation and a 65% probability of rising interest rates with inflation.”

FYI.

Location of errata:

http://stallakb.custhelp.com/cgi-bin/stallakb.cfg/php/enduser/std_adp.ph...

Regards

CP

CP

110% probability… I doubt anybody can explain that.

What makes the 45 + 65 =110 % ???

fsa-sucker, CFA

“There is a 45% probability of rising interest rates with no inflation and a 45+65%=110% probability of rising interest rates with inflation”

You shouldn’t add 45% and 65% together because one is given no inflation while the the latter is given inflation.

R = interest rate rise

I = Inflation

P(R|I) = 0.65 [Rising Interest rates given inflation already occurs]

P(R’|I) = 0.35 [Non rising interest rates given inflation already occurs]

P(R|I’) = 0.45 [Rising interest rates given no inflation already occurs]

P(R’|I’) = 0.55 [Non rising interest rates given no inflation already occurs]

P(I) = 0.6 [Inflation]

P(I’) = 0.4 [No inflation]

Then we can workout

P(RI) = P(R|I) * P(I) = 0.39 [Rising interest rates and inflation]

P(R’I) = 0.21 [Non rising interest rates and inflation]

P(RI’) = 0.18 [Rising interest rates and no inflation]

P(R’I’) = 0.22 [Non rising interest rates and no inflation]

Thus

P(R) = P(RI) + P(RI’) = 0.57 [Rising interest rates]

P(R’) = 0.43 [Non rising interest rates]

P(I|R) = P(IR) / P(R) =0.6842 [Inflation given rising interest rates]

cpk123, Thanks.

Dreary