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Financial Risk Manager Part 1

Financial Risk Manager Part 1

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Consider the following data sets (We are using a small sample size for illustration purposes. In an exam situation, it might involve large sample sizes)

YX1X2
-2-0.41-0.01
-0.110.40-1.2
-1.68-0.86-0.91
-0.361.690.37
-0.080.46-0.64
-0.741.40-1.09

What is the estimated regression equation

Y-hat = alpha + beta_1 X1_

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Explanation:

Why B is correct (quick reasoning)

Check slope (( \beta_1 )) sign:

  • ( X_1 ) goes from (-0.41) to (0.40), and ( Y ) goes from (-2) to (-0.11)
  • As ( X_1 ) increases, ( Y ) increases → positive slope
  • This immediately eliminates options C and D (both have negative ( \beta_1 ))

Check intercept (( \alpha )) sign:

  • For ( X_1 = -0.41 ), with ( \beta_1 \approx 0.96 ), the slope term = ( 0.96 \times -0.41 \approx -0.39 )
  • The actual ( Y ) is (-2), which is much lower, so ( \alpha ) must be negative to bring the prediction down
  • This eliminates option A

Only option B fits:

  • ( \alpha = -0.8967 ) (negative), ( \beta_1 = +0.9633 ) (positive) ✅

Why the others are wrong

  • A: Positive slope (ok) but positive intercept — would overpredict for negative ( X_1 )
  • C/D: Negative slope — contradicts observed positive relationship
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