MBA/PGDBA Sem. II Assignments MBA Assignments MBA/PGDBA Semester II MB0044 – Production & Operations Management Q1.

Explain in brief the origins of Just In Time. Explain the different types of wastes that can be eliminated using JIT Ans. Just in Time (JIT) is a management philosophy aimed at eliminating waste and continuously improving quality. Credit for developing JIT as a management strategy goes to Toyota. Toyota JIT manufacturing started in the aftermath of World War II. Although the history of JIT traces back to Henry Ford who applied Just in Time principles to manage inventory in the Ford Automobile Company during the early part of the 20th Century, the origins of the JIT as a management strategy traces to Taiichi Onho of the Toyota Manufacturing Company. He developed Just in Time strategy as a means of competitive advantage during the post World War II period in Japan. The post-World War II Japanese automobile industry faced a crisis of existence, and companies such as Toyota looked to benchmark their thriving American counterparts. The productivity of an American car worker was nine times that of a Japanese car worker at that time, and Taiichi Onho sought ways to reach such levels. Two pressing challenges however prevented Toyota from adopting the American way:
1. American car manufacturers made “lots” or a “batch”

of a model or a component before switching over to a new model or component. This system was not suited to the Japanese conditions where a small market required manufacturing in small quantities. 2. The car pricing policy of US manufacturers was to charge a mark-up on the cost price. The low demand

in Japan led to price resistance. The need of the hour was thus to reduce manufacturing costs to increase profits. To overcome these two challenges, Taiichi Onho identified waste as the primary evil. The categories of waste identified included
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overproduction inventory or waste associated with keeping dead stock time spent by workers waiting for materials to appear in the assembly line time spend on transportation or movement workers spending more time than necessary processing an item waste associated with defective items

Taiichi Onho then sought to eliminate waste through the just-in-time philosophy, where items moved through the production system only as and when needed. Q2. What is Value Engineering or Value Analysis? Elucidate five companies which have incorporated VE with brief explanation. Ans. Value Engineering (VE), also known as Value Analysis, is a systematic and function-based approach to improving the value of products, projects, or processes.VE involves a team of people following a structured process. The process helps team members communicate across boundaries, understand different perspectives, innovate, and analyze.When to use itUse Value Analysis to analyze and understand the detail of specific situations. Use it to find a focus on key areas for innovation. Use it in reverse (called Value Engineering) to identify specific solutions to detail problems. It is particularly suited to physical and mechanical problems, but can also be used in other areas.

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How it works Value Analysis (and its design partner, Value Engineering) is used to increase the value of products or services to all concerned by considering the function of individual items and the benefit of this function and balancing this against the costs incurred in delivering it. The task then becomes to increase the value or decrease the cost.

Q3. Explain different types of Quantitative models. Differentiate between work study and motion study. Ans. Quantitative models are needed for a variety of management tasks, including (a) identi¯cation of critical variables to use for health monitoring, (b) antici- pating service level violations by using predictive models, and (c) on-going op- timization of con¯gurations. Unfortunately, constructing quantitative models requires specialized skills that are in short supply. Even worse, rapid changes in provider con¯gurations and the evolution of business demands mean that quantitative models must be updated on an on-going basis. This paper de-scribes an architecture and algorithms for on-line discovery of quantitativemodels without prior knowledge of the managed elements. The architecture makes use of an element schema that describes managed elements using the common information model (CIM). Algorithms are presented for selecting a subset of the element metrics to use as explanatory variables in a quantitative model and for constructing the quantitative model itself. We further describe a prototype system based on this architecture

that incorporates these algo-rithms. We apply the prototype to on-line estimation of response times for DB2 Universal Database under a TPC-W workload. Of the approximately 500 metrics available from the DB2 performance monitor, our system chooses 3 to construct a model that explains 72% of the variability of response time. In production and operations management, models refer to any simple representation of reality in different forms such as mathematical equations, graphical representation, pictorial representation, and physical models. Thus a model could be the well known economic order quantity (EOQ) formula, a PERT network chart, a motion picture of an operation, or pieces of strings stretched on a drawing of a plant layout to study the movement of material. The models help us to analyze and understand the reality. These also help us to work determine optimal conditions to for decision making. For example, the EOQ formula helps us to determine the optimum replenishment quantities that minimize the cost of storing plus replenishing.The number of different models we use in production and operations management run into hundreds, or even more than a thousand. These are really too many to enumerate in a place like these. I am listing below a random list of broad categories of models used in production and operations model.Operations research models. This is actually a very broad classification and covers many of the other categories in the list given here.
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Inventory models Forecasting models Network models Linear programming models Queuing models Production planning and control models Engineering drawings Photographs and motion pictures used in time and motion studies. Material movement charts Process flow diagrams Systems charts

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Statistical process control charts. Variance analysis Regression analysis Organization chart Fishbone chart

Work study and motion study Work study includes a wide field of measurement tools and techniques. Motion study or method study is concerned with analyzing individual human motions (like get object, put object) with a view to improving motion economy. Q4. What is Rapid Prototyping? Explain the difference between Automated flow line and Automated assembly line with examples. Ans. Rapid prototyping is the automatic construction of physical objects using additive manufacturing technology. The first techniques for rapid prototyping became available in the late 1980s and were used to produce models and prototype parts. Today, they are used for a much wider range of applications and are even used to manufacture production-quality parts in relatively small numbers. Some sculptors use the technology to produce complex shapes for fine arts exhibitions. Automated flow lines : When several automated machines are linked by a transfer system which moves the parts by using handling machines which are also automated, we have an automated flow line. After completing an operation on a machine, the semi finished parts are moved to the next machine in the sequence determined by the process requirements a flow line is established. The parts at various stages from raw material to ready for fitment or assembly are processed continuously to attain the required shapes or acquire special properties to enable them to perform desired functions. The materials need to be moved, held, rotated, lifted, positioned etc. for completing different operations. Sometimes, a few of the operations can be done on a single machine with a number of attachments. They are

moved further to other machines for performing further operations. Human intervention may be needed to verify that the operations are taking place according to standards. When these can be achieved with the help of automation and the processes are conducted with self regulation, we will have automated flow lines established. One important consideration is to balance times that different machines take to complete the operations assigned to them. It is necessary to design the machines in such a way that the operation times are the same throughout the sequence in the flow of the martial. In fixed automation or hard automation, where one component is manufactured using several operations and machines it is possible to achieve this condition – or very nearly. We assume that product life cycles are sufficiently stable to invest heavily on the automated flow lines to achieve reduced cost per unit. The global trends are favouring flexibility in the manufacturing systems. The costs involved in changing the set up of automated flow lines are high. So, automated flow lines are considered only when the product is required to be made in high volumes over a relatively long period. Designers now incorporate flexibility in the machines which will take care of small changes in dimensions by making adjustments or minor changes in the existing machine or layout. The change in movements needed can be achieved by programming the machines. Provisions for extra pallets or tool holders or conveyors are made in the original design to accommodate anticipated changes. The logic to be followed is to find out whether the reduction in cost per piece justifies the costs of designing, manufacturing and setting up automated flow lines. Group Technology, Cellular Manufacturing along with conventional Product and Process Layouts are still resorted to as they allow flexibility for the production system. With methodologies of JIT and Lean Manufacturing finding importance and relevance in the competitive field of manufacturing, many companies have found that well designed flow lines suit their purpose well. Flow lines compel engineers to put in place equipments that balance their production rates. It is not possible to think of inventories (Work In Process) in a flow line. Bottlenecks cannot be permitted. By necessity,

every bottleneck gets focused upon and solutions found to ease them. Production managers see every bottleneck as an opportunity to hasten the flow and reduce inventories. However, it is important to note that setting up automated flow lines will not be suitable for many industries Automated Assembly Lines: All equipments needed to make a finished product are laid out in such a way as to follow the sequence in which the parts or subassemblies are put together and fitted. Usually, a frame, body, base will be the starting point of an assembly. The frame itself consists of a construction made up of several components and would have been ‘assembled’ or ‘fabricated’ in a separate bay or plant and brought to the assembly line. All parts or subassemblies are fitted to enable the product to be in readiness to perform the function it was designed to. This process is called assembly. Methodologies of achieving the final result may vary, but the basic principle is to fit all parts together and ensure linkages so that their functions are integrated and give out the desired output. Product Layouts are designed so that the assembly tasks are performed in the sequence they are designed. You will note that the same task gets repeated at each station continuously. The finished item comes out at the end of the line The material goes from station 1 to 5 sequentially. Operation 2 takes longer time, say twice as long. To see that the flow is kept at the same pace we provide two locations 2a and 2b so that operations 3, 4 an 5 need not wait. At 5, we may provide more personnel to complete operations. The time taken at any of the locations should be the same. Otherwise the flow is interrupted. In automated assembly lines the moving pallets move the materials from station to station and moving arms pick up parts, place them at specified places and fasten them by pressing, riveting, screwing or even welding. Sensors will keep track of these activities and move the assemblies to the next stage. An operator will oversee that the assemblies are happening and there are no stoppages. The main consideration for using automated assembly lines is that the volumes justify the huge expenses involved in setting

Up the system. Q5.Explain Break Even Analysis and Centre of Gravity methods. Explain Product layout and process layout with examples.

Ans. Break Even Analysis refers to the calculation to determine how much product a company must sell in order to break even on that product. It is an effective analysis to measure the impact of different marketing decisions. It can focus on the product, or incremental changes to the product to determine the potential outcomes of marketing tactics. The formula for a break even analysis is: Break even point ($) = (Total Fixed Costs + Total Variable Costs). Total Variable Costs = Variable cost per unit x units sold Unit contribution (contribution margin) = Price per unit – Variable cost per unit. When looking at making a change to the marketing program, one can calculate the incremental break even volume, to determine the merits of the change. This determines the required volume needed such that there is no effect to the company due to the change. If making changes to fixed costs (changing advertising expenditure etc.): Incremental break even volume = change in expenditure / unit contribution. Thus if a company increased its advertising expenditure by $1 million, and its unit contribution for the specific product is $20, then the company would need to sell an additional 50,000 units to break even on the decision. If making changes to the unit contribution (change in price, or variable costs): Incremental break even volume = (Old Unit Volume x (Old Unit Contribution – New Unit Contribution)) / New Unit Contribution Thus if a company increased its price from $15 to $20, and had variable costs of $10, it is increasing its unit contribution from $5 to $10, assume also an old unit

volume of 1 million. It could therefore reduce its volume by 500,000 to break even on the decision. When making changes to a specific product, cannibalization of other products may occur. To calculate the effect of cannibalization, the Break Even Cannibalization rate for a change in a product is: New Product Unit Contribution / Old Product Unit Contribution. New Product is the planned addition to a product line (or change to a product within a product line), Old Product is the product that loses sales to the new product (or the product line that loses sales). The cannibalization rate refers to the percentage of new product that would have gone to the old product, this must be lower than the break even cannibalization rate in order for the change to be profitable. In manufacturing, facility layout consists of configuring the plant site with lines, buildings, major facilities, work areas, aisles, and other pertinent features such as department boundaries. While facility layout for services may be similar to that for manufacturing, it also may be somewhat different—as is the case with offices, retailers, and warehouses. Because of its relative permanence, facility layout probably is one of the most crucial elements affecting efficiency. An efficient layout can reduce unnecessary material handling, help to keep costs low, and maintain product flow through the facility. Firms in the upper left-hand corner of the product-process matrix have a process structure known as a jumbled flow or a disconnected or intermittent line flow. Upper-left firms generally have a process layout. Firms in the lower righthand corner of the product-process matrix can have a line or continuous flow. Firms in the lower-right part of the matrix generally have a product layout. Other types of layouts include fixed-position, combination, cellular, and certain types of service layouts. PROCESS LAYOUT Process layouts are found primarily in job shops, or firms that produce customized, low-volume products that may

require different processing requirements and sequences of operations. Process layouts are facility configurations in which operations of a similar nature or function are grouped together. As such, they occasionally are referred to as functional layouts. Their purpose is to process goods or provide services that involve a variety of processing requirements. A manufacturing example would be a machine shop. A machine shop generally has separate departments where general-purpose machines are grouped together by function (e.g., milling, grinding, drilling, hydraulic presses, and lathes). Therefore, facilities that are configured according to individual functions or processes have a process layout. This type of layout gives the firm the flexibility needed to handle a variety of routes and process requirements. Services that utilize process layouts include hospitals, banks, auto repair, libraries, and universities. Improving process layouts involves the minimization of transportation cost, distance, or time. To accomplish this some firms use what is known as a Muther grid, where subjective information is summarized on a grid displaying various combinations of department, work group, or machine pairs. Each combination (pair), represented by an intersection on the grid, is assigned a letter indicating the importance of the closeness of the two (A = absolutely necessary; E = very important; I = important; O = ordinary importance; U = unimportant; X = undesirable). Importance generally is based on the shared use of facilities, equipment, workers or records, work flow, communication requirements, or safety requirements. The departments and other elements are then assigned to clusters in order of importance. Advantages of process layouts include:
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Flexibility. The firm has the ability to handle a variety of processing requirements. Cost. Sometimes, the general-purpose equipment utilized may be less costly to purchase and less costly and easier to maintain than specialized equipment.

Motivation. Employees in this type of layout will probably be able to perform a variety of tasks on multiple machines, as opposed to the boredom of performing a repetitive task on an assembly line. A process layout also allows the employer to use some type of individual incentive system. System protection. Since there are multiple machines available, process layouts are not particularly vulnerable to equipment failures.

Disadvantages of process layouts include:

Utilization. Equipment utilization rates in process layout are frequently very low, because machine usage is dependent upon a variety of output requirements. Cost. If batch processing is used, in-process inventory costs could be high. Lower volume means higher perunit costs. More specialized attention is necessary for both products and customers. Setups are more frequent, hence higher setup costs. Material handling is slower and more inefficient. The span of supervision is small due to job complexities (routing, setups, etc.), so supervisory costs are higher. Additionally, in this type of layout accounting, inventory control, and purchasing usually are highly involved. Confusion. Constantly changing schedules and routings make juggling process requirements more difficult.

PRODUCT LAYOUT Product layouts are found in flow shops (repetitive assembly and process or continuous flow industries). Flow shops produce high-volume, highly standardized products that require highly standardized, repetitive processes. In a product layout, resources are arranged sequentially, based on the routing of the products. In theory, this sequential layout allows the entire process to be laid out in a straight line, which at times may be totally dedicated to the production of only one product or product version. The flow of the line can then be subdivided so that labor

and equipment are utilized smoothly throughout the operation. Two types of lines are used in product layouts: paced and unpaced. Paced lines can use some sort of conveyor that moves output along at a continuous rate so that workers can perform operations on the product as it goes by. For longer operating times, the worker may have to walk alongside the work as it moves until he or she is finished and can walk back to the workstation to begin working on another part (this essentially is how automobile manufacturing works). On an unpaced line, workers build up queues between workstations to allow a variable work pace. However, this type of line does not work well with large, bulky products because too much storage space may be required. Also, it is difficult to balance an extreme variety of output rates without significant idle time. A technique known as assembly-line balancing can be used to group the individual tasks performed into workstations so that there will be a reasonable balance of work among the workstations. Product layout efficiency is often enhanced through the use of line balancing. Line balancing is the assignment of tasks to workstations in such a way that workstations have approximately equal time requirements. This minimizes the amount of time that some workstations are idle, due to waiting on parts from an upstream process or to avoid building up an inventory queue in front of a downstream process. Advantages of product layouts include:
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Output. Product layouts can generate a large volume of products in a short time. Cost. Unit cost is low as a result of the high volume. Labor specialization results in reduced training time and cost. A wider span of supervision also reduces labor costs. Accounting, purchasing, and inventory control are routine. Because routing is fixed, less attention is required.

Utilization. There is a high degree of labor and equipment utilization.

Disadvantages of product layouts include:

Motivation. The system’s inherent division of labor can result in dull, repetitive jobs that can prove to be quite stressful. Also, assembly-line layouts make it very hard to administer individual incentive plans. Flexibility. Product layouts are inflexible and cannot easily respond to required system changes— especially changes in product or process design. System protection. The system is at risk from equipment breakdown, absenteeism, and downtime due to preventive maintenance.

_______________________________________________________ MB0045 – Financial Management Q1. What are the 4 finance decisions taken by a finance manager. Ans. A firm performs finance functions simultaneously and continuously in the normal course of the business. They do not necessarily occur in a sequence. Finance functions call for skilful planning, control and execution of a firm’s activities. Let us note at the outset hat shareholders are made better off by a financial decision that increases the value of their shares, Thus while performing the finance function, the financial manager should strive to maximize the market value of shares. Whatever decision does a manger takes need to result in wealth maximization of a shareholder. Investment Decision Investment decision or capital budgeting involves the decision of allocation of

capital or commitment of funds to long-term assets that would yield benefits in the future. Two important aspects of the investment decision are: (a) the evaluation of the prospective profitability of new investments, and (b) the measurement of a cut-off rate against that the prospective return of new investments could be compared. Future benefits of investments are difficult to measure and cannot be predicted with certainty. Because of the uncertain future, investment decisions involve risk. Investment proposals should, therefore, be evaluated in terms of both expected return and risk. Besides the decision for investment managers do see where to commit funds when an asset becomes less productive or non-profitable. There is a broad agreement that the correct cut-off rate is the required rate of return or the opportunity cost of capital. However, there are problems in computing the opportunity cost of capital in practice from the available data and information. A decision maker should be aware of capital in practice from the available data and information. A decision maker should be aware of these problems. Financing Decision Financing decision is the second important function to be performed by the financial manager. Broadly, her or she must decide when, where and how to acquire funds to meet the firm’s investment needs. The central issue before him or her is to determine the proportion of equity and debt. The mix of debt and equity is known as the firm’s capital structure. The

financial manager must strive to obtain the best financing mix or the optimum capital structure for his or her firm. The firm’s capital structure is considered to be optimum when the market value of shares is maximized. The use of debt affects the return and risk of shareholders; it may increase the return on equity funds but it always increases risk. A proper balance will have to be struck between return and risk. When the shareholders’ return is maximized with minimum risk, the market value per share will be maximized and the firm’s capital structure would be considered optimum. Once the financial manager is able to determine the best combination of debt and equity, he or she must raise the appropriate amount through the best available sources. In practice, a firm considers many other factors such as control, flexibility loan convenience, legal aspects etc. in deciding its capital structure. Dividend Decision Dividend decision is the third major financial decision. The financial manager must decide whether the firm should distribute all profits, or retain them, or distribute a portion and retain the balance. Like the debt policy, the dividend policy should be determined in terms of its impact on the shareholders’ value. The optimum dividend policy is one that maximizes the market value of the firm’s shares. Thus if shareholders are not indifferent to the firm’s dividend policy, the financial manager must determine the optimum dividend – payout ratio. The payout ratio is equal to the percentage of dividends to earnings available to shareholders. The financial manager should also consider the questions of

dividend stability, bonus shares and cash dividends in practice. Most profitable companies pay cash dividends regularly. Periodically, additional shares, called bonus share (or stock dividend), are also issued to the existing shareholders in addition to the cash dividend Liquidity Decision Current assets management that affects a firm’s liquidity is yet another important finances function, in addition to the management of longterm assets. Current assets should be managed efficiently for safeguarding the firm against the dangers of illiquidity and insolvency. Investment in current assets affects the firm’s profitability. Liquidity and risk. A conflict exists between profitability and liquidity while managing current assets. If the firm does not invest sufficient funds in current assets, it may become illiquid. But it would lose profitability, as idle current assets would not earn anything. Thus, a proper trade-off must be achieved between profitability and liquidity. In order to ensure that neither insufficient nor unnecessary funds are invested in current assets, the financial manager should develop sound techniques of managing current assets. He or she should estimate firm’s needs for current assets and make sure that funds would be made available when needed. It would thus be clear that financial decisions directly concern the firm’s decision to acquire or dispose off assets and require commitment or recommitment of funds on a continuous basis. It is in this context that finance functions are said to influence production, marketing and other functions of the firm. This, in consequence, finance

functions may affect the size, growth, profitability and risk of the firm, and ultimately, the value of the firm. To quote Ezra Solomon The function of financial management is to review and control decisions to commit or recommit funds to new or ongoing uses. Thus, in addition to raising funds, financial management is directly concerned with production, marketing and other functions, within an enterprise whenever decisions are about the acquisition or distribution of assets. Various financial functions are intimately connected with each other. For instance, decision pertaining to the proportion in which fixed assets and current assets are mixed determines the risk complexion of the firm. Costs of various methods of financing are affected by this risk. Likewise, dividend decisions influence financing decisions and are themselves influenced by investment decisions. In view of this, finance manager is expected to call upon the expertise of other functional managers of the firm particularly in regard to investment of funds. Decisions pertaining to kinds of fixed assets to be acquired for the firm, level of inventories to be kept in hand, type of customers to be granted credit facilities, terms of credit should be made after consulting production and marketing executives. However, in the management of income finance manager has to act on his own. The determination of dividend policies is almost exclusively a finance function. A finance manager has a final say in decisions on dividends than in asset management decisions.

Financial management is looked on as cutting across functional even disciplinary boundaries. It is in such an environment that finance manager works as a part of total management. In principle, a finance manager is held responsible to handle all such problem: that involve money matters. But in actual practice, as noted above, he has to call on the expertise of those in other functional areas to discharge his responsibilities effectively. Q.2 What are the factors that affect the financial plan of a company? Ans. To help your organization succeed, you should develop a plan that needs to be followed. This applies to starting the company, developing new product, creating a new department or any undertaking that affects the company’s future. There are several factors that affect planning in an organization. To create an efficient plan, you need to understand the factors involved in the planning process. A businessman an businesswoman having a meeting image by sumos from Fotolia.com A businessman an businesswoman having a meeting image by sumos from Fotolia.com Organizational planning is affected by many factors. 4e634960-1e4b-65e0-9d0e-ed699b8d2ca4400300

Priorities

In most companies, the priority is generating revenue, and this priority can sometimes interfere with the planning process of any project. For example, if you are in the process of planning a large expansion project and your largest customer suddenly threatens to take their business to your competitor, then you might have to shelve the expansion planning until the customer issue is

resolved. When you start the planning process for any project, you need to assign each of the issues facing the company a priority rating. That priority rating will determine what issues will sidetrack you from the planning of your project, and which issues can wait until the process is complete.

Company Resources

Having an idea and developing a plan for your company can help your company to grow and succeed, but if the company does not have the resources to make the plan come together, it can stall progress. One of the first steps to any planning process should be an evaluation of the resources necessary to complete the project, compared to the resources the company has available. Some of the resources to consider are finances, personnel, space requirements, access to materials and vendor relationships.

Forecasting

A company constantly should be forecasting to help prepare for changes in the marketplace. Forecasting sales revenues, materials costs, personnel costs and overhead costs can help a company plan for upcoming projects. Without accurate forecasting, it can be difficult to tell if the plan has any chance of success, if the company has the capabilities to pull off the plan and if the plan will help to strengthen the company’s standing within the industry. For example, if your forecasting for the cost of goods has changed due to a sudden increase in material costs, then that can affect elements of your product roll-out plan, including projected profit and the long-term commitment you might need to make to a supplier to try to get the lowest price possible.

Contingency Planning

To successfully plan, an organization needs to have a contingency plan in place. If the company has decided to pursue a new product line, there needs to be a part of the plan that addresses the possibility that the product line

will fail. The reallocation of company resources, the acceptable financial losses and the potential public relations problems that a failed product can cause all need to be part of the organizational planning process from the beginning Q.3 Show the relationship between required rate of return and coupon rate on the value of a bond. Ans. It is important for prospective bond buyers to know how to determine the price of a bond because it will indicate the yield received should the bond be purchased. In this section, we will run through some bond price calculations for various types of bond instruments. Bonds can be priced at a premium, discount, or at par. If the bond’s price is higher than its par value, it will sell at a premium because its interest rate is higher than current prevailing rates. If the bond’s price is lower than its par value, the bond will sell at a discount because its interest rate is lower than current prevailing interest rates. When you calculate the price of a bond, you are calculating the maximum price you would want to pay for the bond, given the bond’s coupon rate in comparison to the average rate most investors are currently receiving in the bond market. Required yield or required rate of return is the interest rate that a security needs to offer in order to encourage investors to purchase it. Usually the required yield on a bond is equal to or greater than the current prevailing interest rates. Fundamentally, however, the price of a bond is the sum of the present values of all expected coupon payments plus the present value of the par value at maturity. Calculating bond price is simple: all we are doing is discounting the known future cash flows. Remember that to calculate present value (PV) – which is based on the assumption that each payment is re-invested at some interest rate once it is received–we have to know the interest rate that would earn us a known future value. For bond pricing, this interest rate is the required yield. (If the concepts of present and future value are new to you or

you are unfamiliar with the calculations, refer to Understanding the Time Value of Money.) Here is the formula for calculating a bond’s price, which uses the basic present value (PV) formula:

C = coupon payment n = number of payments i = interest rate, or required yield M = value at maturity, or par value The succession of coupon payments to be received in the future is referred to as an ordinary annuity, which is a series of fixed payments at set intervals over a fixed period of time. (Coupons on a straight bond are paid at ordinary annuity.) The first payment of an ordinary annuity occurs one interval from the time at which the debt security is acquired. The calculation assumes this time is the present. You may have guessed that the bond pricing formula shown above may be tedious to calculate, as it requires adding the present value of each future coupon payment. Because these payments are paid at an ordinary annuity, however, we can use the shorter PV-of-ordinaryannuity formula that is mathematically equivalent to the summation of all the PVs of future cash flows. This PV-ofordinary-annuity formula replaces the need to add all the present values of the future coupon. The following diagram illustrates how present value is calculated for an ordinary annuity:

Each full moneybag on the top right represents the fixed coupon payments (future value) received in periods one, two and three. Notice how the present value decreases for those coupon payments that are further into the future the present value of the second coupon payment is worth less than the first coupon and the third coupon is worth the lowest amount today. The farther into the future a payment is to be received, the less it is worth today – is the fundamental concept for which the PV-of-ordinaryannuity formula accounts. It calculates the sum of the present values of all future cash flows, but unlike the bond-pricing formula we saw earlier, it doesn’t require that we add the value of each coupon payment. (For more on calculating the time value of annuities, see Anything but Ordinary: Calculating the Present and Future Value of Annuities and Understanding the Time Value of Money. ) By incorporating the annuity model into the bond pricing formula, which requires us to also include the present value of the par value received at maturity, we arrive at the following formula:

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