Q UANTITATIVE T ECHNIQUES F INANCE

IN

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
  

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

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

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!

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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?

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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?

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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?

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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?

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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.

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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. System must be user friendly!

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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. System must be observed over time to ensure it works properly.

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E XAMPLE OF DECISION
MAKING PROCESS
 

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

A LTERNATIVES
   

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


Also Consider other alternatives like location, potential advancement etc.

Q UANTITATIVE MODELS

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

Q.T


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


with examples financial applications

L INEAR P ROGRAMMING
M ODELS

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I NTRODUCTION


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

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

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

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C ONT

The word , 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.

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



Galaxy manufactures two toy doll models:

 

Space Ray. Zapper.

Resources are limited to

 

1000 pounds of special plastic. 40 hours of production time per week.

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



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.

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

 The current production plan calls for:


Producing as much as possible of the more profitable product, Space Ray ($8 profit per dozen). Use resources left over to produce Zappers ($5 profit per dozen), while remaining within the marketing guidelines.

The current production plan consists of:

Space Rays = 450 dozen Zapper = 100 dozen Profit = $4100 per week

8(450) + 5(100)

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Management is seeking a production schedule that will increase the companys profit.

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

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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

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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 - X2 e 350 Xj> = 0, j = 1,2
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(Plastic) (Production Time) (Total production) (Mix) (Nonnegativity)

P ROBLEM 1


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

T HE S ERVER P ROBLEM

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, inspection time and storage space. 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.

A DDITIONAL I NFORMATION


In order to develop a suitable model of the problem, the manager has met with design and manufacturing personnel. As a result of these meetings, 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. 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. All of the output can be sold.