Grp- 10

Application of Linear Programming in Finance

Presented to: Prof. Swapna Tamhankar

Date- :21-03-2012

Group Members :

Gitesh Dhotre..P 10 Prashant Khirekar....P 20

Ruchira ghosalkar....P 30
Gladwin Timothy.....P 40

Rakesh ChavanP 50
Pankaj Vyas..P 60

Introduction
A "linear" programming problem assumes a linear objective function, and a series of linear inequality constraints. Constraints of production are capacity, time, money, raw materials, budget, space, etc. Linearity constant prices for outputs (perfectly competitive market). constant returns to scale for production processes. Each decision variable has a non-negativity constraint. For example, the time spent using a machine cannot be negative.

Optimal Feasible Solution

4

The corner point that maximize the objective function is the Optimal Feasible Solution. There may be several optimal solutions. One or more of the constraints may be slack, which means it is not binding. Each constraint has an implicit price, the shadow price of the constraint. If a constraint is slack, its shadow price is zero.

Purchasing Modeling
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These models can consider: Demand Budget Cash flow Advertising Inventory restrictions. Blending problems refer to situations in which a number of components (or commodities) are mixed together to yield one or more products.

Typically, different commodities are to be purchased. Each commodity has known characteristics and costs.
The problem is to determine how much of each commodity should be purchased and blended with the rest so that the

Linear Programming Applications

LP can be used in financial decision-making that involves-:

Capital Budgeting Make-or-Buy Asset Allocation Portfolio Selection Financial Planning

Profit Maximization
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The decision maker wishes to produce the combination of resources that will maximize total income. Example Three television models are to be produced. Each model uses 2, 3, and 4 pounds of plastic respectively. 7000 pounds of plastic are available. No model should exceed 40% of the total quantity produced. The profit per set is $23, $34, and $45 respectively. Find the production plan that maximizes the profit.

Solution
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Max 23X1 + 34X2 + 45X3 S.T. 2X1 + 3X2 + 4X3

With summation variables Without summation variables

X1 X2 .4(X1 + X2 + X3) .4(X1 + X2 + X3) X3 .4(X1 + X2 + X3) X1 + X2 + X3 = X4 X1 .4X4 X2 .4X4 X3 .4X4 X1, X2, X3

X1, X2, X3

TV production spreadsheet
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=SUM(B2:D2) Total production Decisio n Variable s

Percentag e Constraint Plastic s Constrai nt

Portfolio Selection
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The selection of specific investments from among a wide variety of alternatives, for example-stocks and bonds.

A problem encountered by managers of banks, mutual funds, investment services, insurance company. Portfolio models are usually designed to: Maximized return on investment. Minimize risk. Factors considered include: Liquidity requirements. Long and short term investment goals. Funds available. legal, policy, risk factors.

Charles Evaluation (Accountant)

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Jones Investment
Potential Investment Savings Account Certificate of Deposite Atlantic Lighting Arkansas REIT Bedrock Insurance Annuity Nocal Mining Bond Minicomp Systems Antony Hotel Expected Return 4.0% 5.2% 7.1% 10.0% 8.2% 6.5% 20.0% 12.5% Jones's Rating A A B+ B A B+ A C Liquidity Analysis Immediate 5-year immediate immediate 1-year 1-year immediate mediate Risk Factor 0 0 25 30 20 15 65 40

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Joness(Customer) Investment

Portfolio goals Expected annual return of at least 7.5%. At least 50% invested in A-Rated investments. At least 40% invested in immediately liquid investments. No more than $30,000 in savings accounts and certificates of deposit. summary Problem Determine the amount to be placed in each investment. Minimize total overall risk. Invest all $100,000. Meet the investor goals .

Joness Investment Solution

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Variables Xi = the amount allotted to each investment;

Risk function

The Mathematical Model

Minimize 25X3+30X4+20X5+15X6+65X7 + 40X8

Total investment

ST: X1+ X2+ X3+ X4+ X5+ X6 + X7+ X8 = 100,000 Return .04X1+.052X2+.071X3+.10X4+.082X5+.056X6+.27X7+.125X8 7500 X1+ X2+ X5 +X7 50,000 X1+ X3+ X4+ X7 40,000 X1+X2 30,000 Savings/ Certificate All the variables are non-negative
A - Rate
Liquid

Jones Investment
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=SUMPRODUCT(B5,B12,C5 :C12)
=SUMPRODUCT(B5,B12,D 5:D12)

=SUM(B5:B 12)
=B5+B 6

=SUMIF(E5:E12,"A",B5: B12)

=SUMIF(F5:F12,"Immediate",B

Jones Investment
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Recommend Portfolio for Jones Portfolio Amount = 1,00,000

INVESTMENT Savings Account Certificate of Deposit Atlantic Lighting Arkansas REIT Bedrock Insurance Annuity Nocal Mining Bond Minicomp Systems Antony Hotels TOTAL INVESTMENT TOTAL RISK AMOUNT 17333.333 12666.667 0 22666.667 47333.333 0 0 0 100000 Risk Factor 0 0 25 30 20 15 65 40 1626666.667 7500 77333.33333 40000 30000 REQUIREMENTS MIN 7500 MIN 50000 MIN 40000 MAX 30000 Expected Return Rating Liquidity 0.040 A Immediate 0.052 A 5-Year 0.071 B+ Immediate 0.100 B+ Immediate 0.082 A 1-Year 0.065 B+ 1-Year 0.200 A Immediate 0.125 C Immediate

Total Expected Return Total in A-rated Investments Total in Liquid Investments Total in Savings and Certificates of Deposit

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Jones Investment - Sensitivity Report

Jones Investment Input Adjustable Cells Cell $B$5 $B$6 $B$7 $B$8 $B$9 $B$10 $B$11 $B$12 Name Savings Account AMOUNT Certificate of Deposit AMOUNT Atlantic Lighting AMOUNT Arkansas REIT AMOUNT Bedrock Insurance Annuity AMOUNT Nocal Mining Bond AMOUNT Minicomp Systems AMOUNT Antony Hotels AMOUNT Final Value 17333.33333 12666.66667 0 22666.66667 47333.33333 0 0 0 Reduced Cost 0 0 4.666666667 0 0 0.666666667 1.666666667 1.666666667 Objective Coefficient 0 0 25 30 20 15 65 40 Allowable Increase 1.176470588 0.5 1E+30 0.384615385 0.425531915 1E+30 1E+30 1E+30 Allowable Decrease 0.5 1.176470588 4.666666667 1.176470588 0.5 0.666666667 1.666666667 1.666666667

Constraints Cell $B$13 $D$16 $D$17 $D$18 $D$19 Final Shadow Constraint Allowable Allowable Name Value Price R.H. Side Increase Decrease TOTAL INVESTMENT AMOUNT 100000 -7.333333333 100000 4634.146341 6341.463415 Total Expected Return Expected Return 7500 333.3333333 7500 520 380 Total in A-rated Investments Expected Return7333.33333 7 0 50000 27333.33333 1E+30 Total in Liquid Investments Expected Return 40000 4 40000 21111.11111 28888.88889 Total in Savings and Certificates of Deposit Expected Return 30000 -10 30000 17333.33333 6333.333333

Cash Flow Models

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These models cover a planning horizon of several periods. Linking constraints secure the proper transfer of quantities from one period to the next one. The form of these constraints is: Amount this period = Amount last period + Inflow for the period Outflow for the period These models are useful for accounting analysis.

Cash Flow Models

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For example: Casht = Casht-1 + [Interest paid]t [Loan repaid]t

110 = 100 + 30 20

100
t-1

+30
t

110

-20

The Powers Group Cash Flow Problem

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Data There are $9 million available for short-term investments over a period of five months (it is now Jan 1). There are three possible investments. Interest earned on each investment is: 0.7% over two months for two month term account. 1.5% over three months for three months construction loan. 0.2% per one-month period for passbook saving account. Funds invested in term account are not liquid before the term ends. Interest earned on investment before it is matured is calculated

Cash Flow Problem

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Objective function Maximize the book value at the end of May.

Constraints No more than $4 million should be invested in any one of the three short term investments. Total investment each month in the liquid passbook account should be at least $2 million. Cash available at the end of each month should be at least $3.5 mn. Cash available at the end of May should be at least $5 million.

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Cash Flow Problem Solution

Decision variables
Tj = the amount of funds invested in the 2 month term account at the beginning of month j = 1, 2,, 6 (j=1, Jan.) Cj = the amount of funds invested in construction loan at the beginning of month j = 1, 2,, 6 (j=1, Jan.) Pj = the amount of funds invested in passbook saving account at the beginning of month j = 1, 2,, 6 (j=1, Jan.) Summation variables TTj = TTj-1 Tj-2 + Tj

TCj = TCj-1 Cj-3 + Cj

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Cash Flow Problem Solution

Objective function Book value consists of cash, and proportionate interest paid on investments before maturity.
1.007T4 + 1.0035T5 + 1.015C3 + 1.010C4 + 1.005C5 +1.002P5
Half of the full two months interest is considered at the end of May for a 2-month term investment made at the beginning of May. .0035 .0035 May 1 June 1

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Cash Flow Problem Solution

Constraints

Not more than $4,000,000 can be invested in any investment

TTj 4,000,000;TCj 4,000,000;TPj 4,000,000

Total in Passbook Saving is at least $2,000,000

TPj 2,000,000

Total investment at the beginning of each month = cash available for investment at the end of the previous month. Tj + Cj + Pj = Lj-1 Then, Lj 3,500,000for j=Feb, March, ) and L1 = 9,000,000. Also L5 5,000,000

Cash Flow Problem Spreadsheet

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=Sum(I6:I8) Drag back to E5:H5

=1.007*H6+1.015*G7+1.002*I8 Drag back to E9:H9

=H13+I6-G6 =1.007*H6+1.0035*I6+1.015*G7+ =H14+I&7-G7 1.01*H7+1.005*I7+1.002*I8 =(I16 E18)/E18*(12/5) =I8 Drag back to E16:H16 Drag back to column E:H

Capital Rationing

Financial decisions sometimes may be viewed as a linear programming problem.

EXAMPLE: A financial officer may want to maximize the return on investments available, given a limited amount of money to invest. The usual problem in finance is to accept all projects with positive net present values, but sometimes the capital budgets are fixed or limited to create "capital rationing" among projects.

Programming Approach to Cash Transfer

Programming Approach to Cash Concentration

Cash Transfer and ConcentrationGraph

Managing about the target balance

Programming approach to cash transfer and concentration

Conclusion
we have looked at a variety of financialmanagement applications through linearprogramming, including cash transfer & concentration .

References-:
http://www.jstor.org/stable/25060150
http://www.jstor.org/stable/2350937