Q UANTITATIVE T ECHNIQUES F INANCE

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D ECISION

MAKING

Decision making is the term generally associated with the first five steps of the problem solving process. Problem solving can be defined as the process of identifying a difference between the actual and the desired state of affairs and then then taking action to resolve the difference.

P ROBLEM .

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SOLVING STEPS Identify and define the problem Determine the set of alternative solutions Determine the criterion or criteria that will be issued to evaluate the alternatives Evaluate the alternatives choose an alternative Implement the selected alternative Evaluate the results .

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. The first step of decision making is to identify the problem and it ends with the choosing of an alternative.

5 M ETHODOLOGY OF O PERATIONS R ESEARCH * T HE S EVEN S TEPS TO A G OOD OR A NALYSIS Feedback loops at all levels! SINI .

6 M ETHODOLOGY OF O PERATIONS R ESEARCH * T HE S EVEN S TEPS TO A G OOD OR A NALYSIS What are the objectives? Is the proposed problem too narrow? Is it too broad? SINI .

7 M ETHODOLOGY OF O PERATIONS R ESEARCH * T HE S EVEN S TEPS TO A G OOD OR A NALYSIS What are the available alternatives? How will data be collected? How do they differ? SINI .

8 M ETHODOLOGY OF O PERATIONS R ESEARCH * T HE S EVEN S TEPS TO A G OOD OR A NALYSIS What kind of model should be used? Is the model accurate? Is the model too complex? SINI .

9 M ETHODOLOGY OF O PERATIONS R ESEARCH * T HE S EVEN S TEPS TO A G OOD OR A NALYSIS Do outputs match current observations for current inputs? Are outputs reasonable? Could the model be erroneous? SINI .

SINI .10 M ETHODOLOGY OF O PERATIONS R ESEARCH * T HE S EVEN S TEPS TO A G OOD OR A NALYSIS What if there are conflicting objectives? Inherently the most difficult step.

System must be user friendly! SINI .11 M ETHODOLOGY OF O PERATIONS R ESEARCH * T HE S EVEN S TEPS TO A G OOD OR A NALYSIS Must communicate results in layman s terms.

SINI . System must be observed over time to ensure it works properly.12 M ETHODOLOGY OF O PERATIONS R ESEARCH * T HE S EVEN S TEPS TO A G OOD OR A NALYSIS Users must be trained on the new system.

E XAMPLE OF DECISION MAKING PROCESS .

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B. D . Assume that you are currently unemployed Suppose that your job search from has resulted in offers from companies A. c.

A LTERNATIVES .

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Accept the position in A Accept the position in B Accept the position in C Accept the position in D .

D ETERMINE .

THE CRITERIA To evaluate the four alternatives Starting salary (for example) .

Then the best alternative would be the one with the highest salary Single criterion decision problem. Multi criteria decision problem .

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Also Consider other alternatives like location. . potential advancement etc.

Q UANTITATIVE MODELS .

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techniques LPP Integer programming Network models Project scheduling PERT/CPM Inventory models Queuing models Simulation Forecasting . O.R.

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IN F INANCE A course in which you learn how to apply OR and statistical models in financial decision making. Techniques such as LPP Forecasting techniques PERT / CPM Regression analysis .

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with examples financial applications .

L INEAR P ROGRAMMING M ODELS .

19 I NTRODUCTION .

. which is to be obtained in the best possible or optimal manner. Linear programming deals with the optimization (Maximization or minimization) of a function of variables known as objective function. cost. The objective function may be profit. subject to a set of linear equations and/or inequalities known as constraint. production capacity or any other measure of effectiveness.

etc. The constraint may be imposed by different resources such as market demand. SINI . production process and equipment. raw material availability. storage capacity.

20 C ONT « .

The term Linear is used to describe the proportionate relationship of two or more variables in a model. SINI . The given change in one variable will always cause a resulting proportional change in another variable.

21 C ONT « .

SINI . Programming is used to specify a sort of planning that involves the economic allocation of limited resources by adopting a particular course of action or strategy among various alternatives strategies to achieve the desired objective. The word .

22 T HE G ALAXY I NDUSTRIES P RODUCTION P ROBLEM ± A P ROTOTYPE E XAMPLE .

Zapper. Galaxy manufactures two toy doll models: Space Ray. .

SINI . Resources are limited to 1000 pounds of special plastic. 40 hours of production time per week.

23 T HE G ALAXY I NDUSTRIES P RODUCTION P ROBLEM ± A P ROTOTYPE E XAMPLE .

‡ Technological input ± Space Rays requires 2 pounds of plastic and 3 minutes of labor per dozen. ± Zappers requires 1 pound of plastic and 4 minutes of labor per dozen. SINI . Marketing requirement Total production cannot exceed 700 dozens. Number of dozens of Space Rays cannot exceed number of dozens of Zappers by more than 350.

24 T HE G ALAXY I NDUSTRIES P RODUCTION P ROBLEM ± A P ROTOTYPE E XAMPLE .

Space Ray ($8 profit per dozen). ‡ The current production plan consists of: Space Rays = 450 dozen Zapper = 100 dozen Profit = $4100 per week 8(450) + 5(100) SINI . Use resources left over to produce Zappers ($5 profit per dozen). The current production plan calls for: Producing as much as possible of the more profitable product. while remaining within the marketing guidelines.

25 Management is seeking a production schedule that will increase the company¶s profit. SINI .

SINI .26 A linear programming model can provide an insight and an intelligent solution to this problem.

27 T HE G ALAXY L INEAR P ROGRAMMING M ODEL Decisions variables: : .

X1 = Weekly production level of Space Rays (in dozens) X2 = Weekly production level of Zappers (in dozens). .

Objective Function: Weekly profit. to be maximized SINI .

j = 1.X2 e 350 Xj> = 0.28 T HE G ALAXY L INEAR P ROGRAMMING M ODEL Max 8X1 + 5X2 (Weekly profit) subject to 2X1 + 1X2 e 1000 3X1 + 4X2 e 2400 X1 + X2 e 700 X1 .2 SINI (Plastic) (Production Time) (Total production) (Mix) (Nonnegativity) .

P ROBLEM 1 .

A retired person wants to invest up to an amount of Rs. His broker recommends investing in two bonds. 6000 in Bond A. he also wants the amount invested in bond A to be at least equal to the amount invested in bond B.000 in fixed income securities. 12000 in bond B and at least Rs. he decides to invest at most Rs. 30. After some consideration. Bond A yielding 7% and bond B yielding 10%. what should the broker recommend if the investor wants to maximize his return on investment ? .

T HE S ERVER P ROBLEM .

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General Description A firm that assembles computers and computer equipment is about to start production of two new Web Server models. Each type of model will require assembly time. . The amounts of each of these resources that can be devoted to the production of the servers is limited. The manager of the firm would like to determine the quantity of each model to produce in order to maximize the profit generated by sales of these servers. inspection time and storage space.

A DDITIONAL I NFORMATION .

As a result of these meetings. the manager has met with design and manufacturing personnel. These daily amounts are: Resource Assembly time Inspection time Storage space Amount available 100 hours 22 hours 39 cubic feet The manager also met with the firms marketing manager and learned that the demand for the servers was such that whatever combination of these two models of servers is produced. In order to develop a suitable model of the problem. . All of the output can be sold. the manager has obtained the following information: Parameter Profit per unit Assembly time per unit Inspection time per unit Storage space per unit Server Type 1 USD 60 4 hours 2 hours 3 cubic feet Server Type 2 USD 50 10 hours 1 hour 3 cubic feet The manager also has acquired information on the availability of company resources.