c: Distinguish among empirical, a priori, and subjective probabilities.
We can assign probabilities to events three ways:

  1. We calculate an empiricalprobabilityby analyzing past data.

  2. We calculate an a priori probability by using formal reasoning and inspection.

  3. A subjective probabilityis less formal and involves personal judgment.

d: Describe the investment consequences of probabilities that are inconsistent.
With respect to investment opportunities, when two assets are price based upon different probabilities being assigned to the same event, this is called inconsistent probabilities.It is best defined by a general example.
Example:Event E will increase the return of both stock A and B. The price of stock A incorporates a higher probability of E than does stock B. All other things equal, stock A is overpriced when compared to stock B. Therefore, an investor should lower holdings of stock A and increase holdings of stock B. An investor that is not too risk averse might engage in a