Decision Making under Uncertainty

End of Slot Examination (2013-14)

Maximum time allotted: 120 minutes (2 hours)

This is an open-book open-notes examination.

The question paper consists of four printed pages containing two questions.
Please write your final answers in blue or black ink in the answer-sheet provided. We will not consider any work done on rough sheets.
Write legibly. If we cannot read your response, you will not be awarded marks
for your response.
We expect your numerical answers to be correct up to three places following
the decimal point.
In case you need to make any assumptions, please state them clearly on the
answer-sheet.

The assumptions will be taken into account only if they are considered reasonable by the instructors.

GOOD LUCK!

Problem 1: (4+3+3+4+4+4+4+4 = 30 marks)

The Well-known Software Company, WSC, has decided to go public, and the market is abuzz
with excitement. The company wants to cash in on its popularity and has decided that anyone must buy at least 1000 shares of the company (at $10 apiece) to become a stakeholder.
It is expected that most of the people interested in buying the shares will be small investors
and will buy exactly 1000 shares each. There will also be wealthy investors who will buy at
least 10,000 shares each. The wealthy investors are expected to buy 12,000 shares each on
average. The market prediction is that at the end of year 1, there is 30% chance of WSC
making a profit of 25%, 30% chance of it making a profit of 10%, and a 40% chance of WSC
making a loss of 40%. The profit/loss will be reflected directly in the share prices: in case of a
profit (or loss) of % the share price will go up (respectively, go down) by %. To attract
wealthy investors, WSC has advertised that they will pay a bonus of 20% of the profit rate
(only if they make a profit) to whoever buys at least 10000 shares.
Consider two investors, a small investor A, who will buy 1000 shares, and a wealthy investor
B, who will buy 12000 shares. Both investors are looking at a time horizon of one year.
(a) What will be the profit expectations of A and B if they invest in WSC shares for one
year?
To make the investment in their company attractive to the small investors, WSC has decided
to offer the services of an independent fund manager. One service that the fund manager
offers is the following. You can invest your money, whatever you have invested in WSC otherwise, with the fund manager, and the fund manager pays you a steady rate of 6% per annum on your investment. The fund manager absorbs 80% of whatever profit or loss you
would have made, had you invested the money directly with WSC, and pays you (or charges
you in case of a loss) the remaining 20%.
(b) Should investor A avail of this service? What is the expected value of the service to
investor A?
(c) Should investor B avail of this service? What is the expected value of the service to
investor B?
(d) Based on the information given above, within what range of the premium rate (currently at 6%) would investor A and investor B take different decisions about availing
the service?
The fund manager also offers service at an advisory role. Depending on the mood of the
market they are going to predict whether WSC will make profit at the end of the first
year or not and, for a $500 fee, make a suggestion to their client on whether to invest in
WSC shares or not. Their suggestion will not include any information on what the profit
margins might be. If they suggest for an investor to invest, then there is 40% chance of
making a profit of 25%, and 30% chance of it making a profit of 10%. If they suggest not
investing, then there is 70% chance of making a loss of 40%. If an investor decides to
avail of this service, and the fund manager suggests that she should invest, she can pay a

flat fee of $500 for the suggestion and invest independently. Alternatively she can pay
only 40% of the fee and invest through the fund manager. In case their suggestion is that
she should not invest, she pays the $500 fee to the fund manager and follows the suggestion.
(e) Consider investor A. Assuming that they make use of the advisory service of the fund
manager, how should they invest (or not invest)? What is the expected value of the
fund managers advice for investor A?
(f) What course of action should investor A take? What is the expected profit of Investor A at the end of one year with their optimal course of action?
(g) Consider investor B. Assuming that they make use of the advisory service of the fund
manager, how should they invest (or not invest)? What is the expected value of the
fund managers advice for investor B?
(h) What course of action should investor B take? What is the expected profit of Investor B at the end of one year with their optimal course of action?

Problem 2: (6+6+4+6+4 = 26 marks)

The process of applying for renewal of passports in a small city is the following. The applicant goes to the passport office and joins a queue to get their file prepared. There are three
people preparing the files. Once an applicant reaches the head of the queue, they are guided to the next available person among the three who will prepare their file. (Only one person prepares an applicants file.) The time required to prepare an applicants file follows an
exponential distribution with a mean of 5 minutes.
On obtaining their file, the applicant joins a queue for the next stage in which their biometric data is obtained. There are 12 kiosks for this stage. Once they reach the head of this
queue, an applicant is guided to the next available kiosk. The biometric equipment at any
kiosk has a 10% chance of breaking down at any stage. In case the equipment at a kiosk is
functioning, this stage requires 3 minutes, and in case the equipment breaks down, then the
time required for this process follows a shifted exponential distribution with a minimum
processing time of 10 minutes and mean processing time of 15 minutes. An applicant is NOT
allowed to change kiosks even if the equipment at a particular kiosk breaks down.
Once an applicants biometric data are collected, they join the queue for the last stage
where their documents are checked. There are two people checking the documents, and
each applicants document is checked by one person. When an applicant reaches the head
of this queue, they are guided to the next person available to check their documents. The
document checking process requires time that is uniformly distributed (i.e., has a rectangular distribution) between 10 minutes and 20 minutes. Once this stage is over, the applicants
application process is complete and the applicant is free to leave.
Six people, A, B, C, D, E, and F are scheduled to apply for renewal of passports on a particular day. They arrive in the same order (i.e., A followed by B, followed by C and so on) and

join the queue for getting their files prepared. All of them arrive before the office opens.
Assume that the time the passport office opens is 0 minutes and simulate the application
process for the six people using the following random numbers in the sequence in which
they are provided, and answer the questions given below.
Sequence Random
number
0.304
1
0.591
2
0.105
3
0.992
4
0.088
5
0.298
6
0.596
7
0.021
8
0.209
9
0.784
10

Sequence Random
number
0.002
11
0.444
12
0.590
13
0.506
14
0.974
15
0.878
16
0.667
17
0.127
18
0.392
19
0.447
20

Sequence Random
number
21
0.361
22
0.943
23
0.787
24
0.326
25
0.377
26
0.852
27
0.281
28
0.452
29
0.375
30
0.014

(a) At what time points do the six applicants join the queue for submitting their biometric data?
For each person who is at the head of the queue to submit the biometric data, choose
a pair of random numbers consecutive in sequence from the random numbers given
above. Use the first random number to simulate whether or not the biometric equipment is functioning and the other to find the time they require to submit the data. For
example, if you decide to choose random numbers 29 and 30 for an applicant, use the
29th random number to simulate whether or not the biometric equipment is functioning
and the 30th random number to simulate the time required.
(b) At what time points do the six applicants join the queue for the last stage?
(c) Develop a 95% confidence interval for the average time required from joining the
queue for submitting biometric data till the time the process of collecting biometric
data is complete.
(d) At what time points do the six applicants complete their processes of application for
renewal of passports?
(e) Develop a 95% confidence interval for the average time required to apply for renewal of passports.
Note:

= 1.960,

( dof, .

= 2.776,

( dof, .

= 2.571, and

--- oOo ---

( dof, .

= 2.447.