Ramon V.

Del Rosario College of Business

De La Salle University – Manila

In Partial Fulfillment
of the Course Requirement in
MSC560M-G02
Quantitative Methods for Decision Making
Term 3, A.Y. 2020-2021

MIDTERM GAME 1 PART IV PROBLEM SOLVING

Submitted by:
Group 1 and 3
Bautista, Anna Mae
Baylon, Johanna Lyn
Jiang, Mingli
Paraiso, Meryll Monica
Santos, Aeron Joseph

Submitted to:
Dr. Dennis Berino, DBA

Date:
07 August 2021
1. Forecasting

1.1 Forecast stock index for period 11 using the following

approaches. Interpret fully the results for each computation.

Approach Period 11 MAD MAPE MSE BIAS SE

Moving average base 2 (a) 15,208.5 374.38 2.52% 202,159 313.25 519.18

Moving average base 3 (a) 15,062 451.33 3.041% 279,644 435.24 625.70

Simple exponential smoothing with 14,937.15 474.05 3.186% 331,099 470.05 652.46
alpha = 0.3 (b)

Simple exponential smoothing with 15,348.2 316.34 2.13% 161,166 266.70 455.21
alpha = 0.7 (b)

Time series regression (c) 15,608.33 191.72 1.316% 47,061 -0.001 242.54

(Please refer to appendix for QM for Windows Solutions)

Among the five approaches, the one that would provide the best forecast is the
time series regression as it yields the lowest MAD, MAPE, MSE, Bias and Standard
Error.

1.2 Develop a regression model to predict the price of Stock A

based on the Stock Index. Interpret fully the results of your
computations.

The regression model developed to predict the the price of Stock A based on the
Stock Index is:
Y =51.207 +.0 x

With a correlation coefficient of 0.107, this model indicates that changes in the
Stock Index barely affects the price of Stock A.
 1.3 Develop a regression model to predict the price of
Stock B based on the Stock Index. Interpret fully the results of
your computations.

The regression model developed to predict the the price of Stock A based on the
Stock Index is:
Y =−47.217+.006 x

With a correlation coefficient of 0.967, this model indicates that as the Stock
Index rises, so does the price of Stock B and vice versa.

1.4 Which of the two stocks’ performance is explained

better by the Stock Index. Cite reasons for your answer.

Among the two stocks, Stock B’s performance is explained better by the Stock
Index as its correlation coefficient of 0.967 is higher than that of Stock A which is 0.107.
Correlation coefficient is a measure that quantifies the strength of the linear
relationship between 2 variables - the closer this value to 1 indicates a positive linear
relationship between the 2 variables. Thus, as the Stock Index rises, so does the
performance of Stock B.

1.5 Identify three (3) other variables other than Stock Index
which can be used to predict the stock price performance. Give a
short explanation for this.

A. Earnings (Net Income)

The strong earning potential of the company increases the attractiveness
of the stocks to investors as it shows effectiveness of the company to generate
earnings from its existing capital. The higher the earning potential of the
company, the higher is the demand for the stock and thus drives the stock price
to rise or increase.
 B. Volume
Volume measures the number of shares traded in a stock or contracts
traded in futures or options. Volume can be an indicator of market strength, as
rising markets on increasing volume are typically viewed as strong and healthy.
When prices fall on increasing volume, the trend is gathering strength to the
downside.

C. Book Value
The book value denotes the intrinsic value of the company. Value
investors rely on this information to assess the should-be value of stocks and
determine whether stocks are overvalued or undervalued.

D. Market Capitalization
Investors can use market capitalization to assess the value of a stock they
are considering buying. Market capitalization is a key measure of profitability that
is also used in equations to determine price-to-earnings and other significant
metrics.

Ethical Considerations

A. Insider Trading
Is a practice of purchasing or selling stocks while in possession of privileged
information that is not yet available to the public. This material non-public information
may significantly affect the prices of the stock price and provide unfair advantage to the
trader against the other inventors and make potentially larger, unfair profits.
 B. Pump and Dump
It is the scheme wherein a group of traders spread misleading information to
excite and catch market interest on certain stocks with an aim to “pump” its price. Once
the stock hypers reach their target inflated price, they will sell and dump the shares and
profit from the stock price appreciation. This practice is considered unethical because
the misleading information entices unsuspecting investors to buy overpriced stocks and
leave their portfolios at a loss once the price falls.

C. Short Selling
Is the practice of selling borrowed stocks at a high price, hoping to make a profit
by purchasing them at a lower price than selling at a later date. The main ethical concern
is that short selling can cause significant market declines and that investment firms profit
when companies fall in value. Short selling is often associated with lurid headlines
predicting corporate failure, market abuse, and policymakers’ concerns that the practice
undermines financial markets.

2. Decision analysis
2.1 What is the best action plan for the company under the following:

Alternatives EMV Maximin Maximax Realism (0.3) Realism

(0.8)

Large 96,667 -310,000 500,000 -67,000 338,000

Medium 140,000 -100,000 400,000 50,000 300,000

Small 86,667 -40,000 200,000 32,000 152,000

No Facility 0 0 0 0 0

Best Alternative Medium No Large Medium Large

facility Facility Facility Facility
(Please refer to appendix for QM for Windows outputs)

a. Maximax. Under the maximax criterion, a large facility will be built with the
highest expected profit of 500,000 out of all the alternatives.
 b. Maximin. Under the maximin criterion, no facility will be built as it yields
the least possible loss among the alternatives.
c. Equally Likely. Under the equally likely approach, a medium facility will be
selected as it yields the highest expected monetary value of 140,000.
d. Realism.
i. Alpha at 0.3. With an alpha of 0.3, a medium facility will be built as
it yields the best payoff among the alternatives of 50,000.
ii. Alpha at 0.8. With an alpha of 0.8 which is leaning on the optimistic
outlook, a large facility will be built as it yields the best payoff
among the alternatives of 338,000.

2.2 The company was able to determine the probability of

occurrence of the market condition as follows: strong at 50%, fair
at 30%, and poor at 20%. What is the best decision for the
company? (please refer to appendix for QM outputs)
Using the expected value approach, the company should build a large
facility as it has the highest expected value at 218,000 among all the
alternatives.

● What is the value of perfect information? How can the company make
use of this result?

For the company, the value of perfect information is 68,000, which is the
variance of the perfect probability of 286,000 and the best expected
value of 218,000. Using this information, the company can set a limit of
68,000 as to the amount they will pay to acquire the perfect information.
In the event that the company will be able to acquire perfect information
at less than 68,000, this will yield to profit and vice versa.

● What is the opportunity loss?

Alternatives Maximum Regret Expected Regret

Large 310,000 68,000

Medium 100,000 70,000

Small 300,000 164,000

 No Facility 500,000 286,000

Minimax Regret 100,000

The opportunity loss for each alternative is shown in the table

above (please see appendix for QM output). For the company the
alternative that will yield the lowest opportunity loss or regret is the
medium facility which has a maximum regret of 100,000.

● What is the decision under criterion of rationality?

The criterion of rationality assumes that all states are equally
likely Under this criterion, the best decision is to build a Medium facility
as it yields the highest EMV of 140,000.

● What is the decision under maximum likelihood?

In maximum likelihood, we’ll be selecting the state with highest
probability and choose the decision with the best pay-off. Under this
criterion, a strong market has the highest probability of occurring where
building a large facility will yield the best pay-off.

2.3 Suppose the probabilities are changed as follows – strong is

30%, fair is 50% and poor is 20%. Use decision trees to find the
best solution for the company. Compare with the result in 2.2.
(please refer to appendix for QM for Windows outputs)

With the following change in the occurrence probabilities of each result, the best
decision the company could make also changed from opening a large facility to opening
a medium facility instead.

Ethical Considerations
 A. Environmental responsibility
Every business owner is responsible for the carbon footprint of his company. This
applies to how your business affects air quality, water cleanliness, the safety of
endangered species, the use and protection of other natural resources, the pristine nature
of protected nature reserves, and so on. Therefore, the equipment invested by the factory
must meet the environmental protection requirements, reduce energy consumption, and
reduce the impact on global warming.

B. Health and safety

Few ethical issues in business are more serious than the health and safety of your
employees and customers. In addition to the obvious moral impact of people being
injured or ill while working for your business, your business's financial stability and
reputation are also at great risk. Therefore, when considering the invested facilities, the
company needs to put the safety impact of the facilities on relevant personnel first and
choose safe and healthy facilities.

C. Accounting Practices
Any organization must maintain accurate bookkeeping practices. “Cooking the
books”, and otherwise conducting unethical accounting practices, is a serious concern for
organizations, especially in publicly traded companies. Even small privately held
companies must keep accurate financial records to pay appropriate taxes and employee
profit-sharing, or to attract business partners and investments.
3. References
Team, T. I. (2021, June 9). Company earnings and EPS: Everything investors need to
know. Investopedia. https://www.investopedia.com/articles/basics/03/052303.asp.

Mitchell, C. (2021, July 27). How to use volume to improve your trading. Investopedia.
https://www.investopedia.com/articles/technical/02/010702.asp.

Beattie, A. (2021, January 14). What book value means to investors. Investopedia.
https://www.investopedia.com/articles/fundamental-analysis/09/book-value-basics.asp.

Team, T. I. (2021, July 21). How can i use market capitalization to evaluate a stock?
Investopedia. https://www.investopedia.com/ask/answers/042415/how-can-i-use-market-
capitalization-evaluate-stock.asp.

Corporate Finance Institute. 2021. Short Selling.

https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/short-selling/

Shabat, B. (2021, January 7). 8 Common Ethical issues Facing Businesses in 2020 |.
Become. https://www.become.co/blog/ethical-issues-businesses/

Lamont, D. (2021, January 7). GameStop: the ethics of short sellers.

https://www.schroders.com/en/insights/economics/are-short-sellers-ethical/

Choueiry, G. (n.d.). Relationship Between r and R-squared in Linear Regression.

https://quantifyinghealth.com/relationship-between-r-and-r-squared/
4. Appendix
1.1 a. Moving average base 2

1.1 a. Moving average base 3

1.1 b. Simple exponential smoothing with alpha = 0.3

1.1 b. Simple exponential smoothing with alpha = 0.7

1.1 c. Time series regression

1.2 Regression model (Stock A)

1.3 Regression model (Stock B)

2.1 d. Realism with alpha at 0.3

2.1 d. Realism with alpha at 0.8

2.2 Decision Table

2.2 a. Perfect information

2.2 b. Opportunity loss

2.3 Decision Trees