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Module A -Quantitative
Techniques and Business
Mathematics
Madhav K Prabhu
M.Tech, MIM, PMP, CISA, CAIIB, CeISB, MCTS, DCL
Agenda
Objectives
What do we mean by Time value of money
Present Value, Discounted Value, Annuity
Interest Rate
No. of Years
Future Value
FV
Interest Amount
20,000
10%
20,000
10%
20,000
10%
22,000
24,200
2,000
2,200
26,620 do
2,420 Compounding?
Compounding
Compounding Formula
FVn P * (1 i ) n
What if compounding is done on monthly basis?
i
FVn P * 1
t
n*t
20,000
No. of Years
12
12
12
22,094
24,408
26,964
2,094
4,408
6,964
Interest Amount
FV
10%
20,000
Interest Rate
Maturity Value
10%
20,000
10%
Compounding Exercise
Exercise:
Prepare a table showing compounding as per
following conditions:
Rate of Interest - 5%, 12% and 15%
Compounding 2 & 4 times in a year
Principal Rs.100,000/-
Discounting
Present Value
You have an option to receive Rs. 1,000/- either today or after
one year. Which option you will select? Why?
Decision will depend upon the present value of money; which
can be calculated by a process called Discounting (opposite of
Compounding)
Interest Rate and Time of Receipt of money decide Present
Value
What is the present value of Rs. 1,000/- today and a year later?
To compute Present Value?
Discounting
contd
1 i n
1000
1 10% 1
Whereas the value of money to be received today will be Rs. 1,000/What if you were to choose between:
a.
b.
Discounting of a Series
contd
20,000
10%
3
15,026.30
Periodic Discounting
What if the receipts are over six months
interval ? Find Present Value of the money
receipts
Receive Rs. 1,000/- at the end of every 6 months for 1-1/2 years OR
Receive Rs. 2,600/- today
Assume Rate of interest @10%
Periodic
Discounting
Formula
P
PV
i
1
t
1000
1
10%
1
1000
10%
1
1000
10%
1
Generically expressed,
the formula is:
SUMofPV
N
xn
Assuming Discounting Done Semi-Annually
n
Principal
P
1,000
1,000
1,000
i
n 1
1
Interest Rate
i
10%
10%
10%
t
HY
n
1
2
3
Times Discounting in a Year
t
2
2
2 Here, N = 3
Discount Factor
DF
0.9524 0.9070 0.8638
Present Value
PV=P*DF 952.38 907.03 863.84
2,723.25
Sum of Present Value
Charting of Cashflow
For any financial proposition prepare a chart of cashflow: e.g.
Invested in 10% Bonds
Interest received
Interest received
New Bond Purchased from
Open Market
Interest received
Sold Bond in Open Market
01-Jan-04
30-Jun-04
31-Dec-04
(1,000) Outflow
50 Inflow
50 Inflow
31-Dec-04
(1,020) Outflow
30-Jun-05
30-Jun-05
100
2,050
Inflow
Inflow
+ 100
+2,050
+2,150
31.12.04
Timeline
30.06.04
Invested in Bonds
(1,000)
Interest Received
Sold Bond
Total
30.06.05
Interest Received
New Bond Purchased
Net
+ 50
(1,020)
( 970)
Net Present Value means the difference between the PV of Cash Inflows &
Cash Outflows
How do you compute NPV?
Find present values of Inflows & Outflows by applying Discount Factor (or
Present Value Factor)
NPV = (PV of Inflows) LESS (PV of Outflows); Result can be +ve OR -ve
Continuing with our example of Bond Investment:
Interest Received
Sold Bond
Total
Inflow
Interest Received +50
01.01.0
4
31.12.04
Timeline
30.06.04
Invested in Bonds
(1,000)
Outflow
30.06.05
Interest Received
New Bond Purchased
Net
+ 100
+2,050
+2,150
+ 50
(1,020)
( 970)
NPV
contd
Description
Invested in 10% Bonds
Interest received
Interest received
New Bond Purchased from
Open Market
Interest received
Sold Bond in Open Market
How these values are arrived at?
Date
Amount In / Out
01-Jan-04
(1,000) Outflow
30-Jun-04
50
Inflow
31-Dec-04
50
Inflow
31-Dec-04
30-Jun-05
30-Jun-05
(1,020) Outflow
100
2,050
PV Outflow PV Inflow
(1,000.00)
47.62
45.35
(925.17)
Inflow
Inflow
Sum
(1,925.17)
Net Present Value
86.38
1,770.87
1,950.22
25.05
What is IRR?
Description
Composit
Flow
01-Jan-04 (1,000)
30-Jun-04
50
Date
Invested in Bonds
Interest received
Interest received + New Bond
31-Dec-04
Purchased
Interest received + Sold Bond
30-Jun-05
IRR of entire cashflow
(970)
2,150
11.38%
IRR
Contd
1000
11.38%
1
Description
50
1
11.38%
1
Date
Invested in Bonds
01-Jan-04
Interest received
30-Jun-04
Interest received +
31-Dec-04
New Bond Purchased
Interest received +
30-Jun-05
Sold Bond
IRR of entire cashflow
970
11.38%
1
Composit
Flow
(1,000)
50
(970)
2,150
11.38%
PV Factor
2150
11.38%
1
NPV at
IRR
1.00000 (1,000.00)
0.94615
47.31
0.89520
0.84699
Sum of PVs
(868.34)
1,821.04
0.00
+500,000
01.02.200
6
01.03.200
6
01.04.200
6
01.01.200
6
-15,000
-15,000
-15,000
n 1
36
01.11.200
8
01.12.200
8
-15,000
-15,000
End
Formula
Expression
N
35
Values in Expression
xn
i
1
t
36 15,000n
500,000
n
n 1
i
1
12
Value of i
to be
determined
contd
+500,000
01.02.200
6
01.03.200
6
01.04.200
6
-15,000
-15,000
-15,000
-15,000
35
36
01.12.200
8
01.01.200
9
-15,000
-15,000
End
01.01.200
6
Formula
Expression
N
P X1
n2
Values in Expression
xn
i
1
t
36
500,000 - 15,000
1 n2
15,000n
i
1
12
Value of i
to be
determined
BOND VALUATION
Objectives
Distinguish bonds coupon rate, current
yield, yield to maturity
Interest rate risk
Bond ratings and investors demand for
appropriate interest rates
Bond characteristics
Bond - evidence of debt issued by a body
corporate or Govt. In India, Govt predominantly
A bond represents a loan made by investors to the
issuer. In return for his/her money, the investor
receives a legaI claim on future cash flows of the
borrower.
The issuer promises to:
Make regular coupon payments every period until the bond
matures, and
Pay the face/par/maturity value of the bond when it matures
Time
0
1
2
3
4
5
Coupons
Rs.80 Rs.80 Rs.80 Rs.80 Rs.80
Face Value
1000
Market Price
Rs.____
How much is this bond worth? It depends on the level of current
market interest rates. If the going rate on bonds like this one is 10%,
then this bond has a market value of Rs.924.18. Why?
Coupon payments
PV ( price) of bond
80
80
80
80
80
1000
Annuity component
2
1 r (1 r )
(1 r ) n
Lump sum
component
Bond terminology
Yield to Maturity
Discount rate that makes present value of
bonds payments equal to its price
Current Yield
Annual coupon divided by the current
market price of the bond
Rate of return
Rate of return
= Coupon income + price change
---------------------------------------Investment
e.g. you buy 6 % bond at 1010.77 and sell next
year at 1020
Rate of return = 60+9.33/1010.77 = 6.86%
Risks in Bonds
Interest rate risk
Short term v/s long term
Default risk
Default premium
Bond pricing
SAMPLING
Objectives
Sample
Definition
Part or portion of
population chosen for
study
Characteristics and
Symbols
Parameters
Population size = N
Population mean = m
Population standard
deviation = s
Statistics
Sample size = n
Sample mean = x
Sample standard deviation
=S
Types of sampling
Non random or judgement
Random or probability
Methods of sampling
Sampling is the fundamental method of inferring
information about an entire population without going to
the trouble or expense of measuring every member of
the population. Developing the proper sampling
technique can greatly affect the accuracy of your results.
Random sampling
Members of the population are chosen in
such a way that all have an equal chance
to be measured.
Other names for random sampling include
representative and proportionate
sampling because all groups should be
proportionately represented.
Definitions
Density Curve (or probability density
function)
the graph of a continuous probability distribution
The total area under the curve must equal 1.
Every point on the curve must have a vertical height that is 0 or
greater.
Definition
Standard Normal Deviation
a normal probability distribution that has a
mean of 0 and a standard deviation of 1
Definition
Standard Normal Deviation
a normal probability distribution that has a
mean of 0 and a standard deviation of 1
Area = 0.3413
Area
0.4429
-3
-2
-1
Score (z )
z = 1.58
Table A-2
=0
.00
.01
.02
.03
.04
.05
.06
.07
.08
.09
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
2.0
2.1
2.2
2.3
2.4
2.5
2.6
2.7
2.8
2.9
3.0
.0000
.0398
.0793
.1179
.1554
.1915
.2257
.2580
.2881
.3159
.3413
.3643
.3849
.4032
.4192
.4332
.4452
.4554
.4641
.4713
.4772
.4821
.4861
.4893
.4918
.4938
.4953
.4965
.4974
.4981
.4987
.0040
.0438
.0832
.1217
.1591
.1950
.2291
.2611
.2910
.3186
.3438
.3665
.3869
.4049
.4207
.4345
.4463
.4564
.4649
.4719
.4778
.4826
.4864
.4896
.4920
.4940
.4955
.4966
.4975
.4982
.4987
.0080
.0478
.0871
.1255
.1628
.1985
.2324
.2642
.2939
.3212
.3461
.3686
.3888
.4066
.4222
.4357
.4474
.4573
.4656
.4726
.4783
.4830
.4868
.4898
.4922
.4941
.4956
.4967
.4976
.4982
.4987
.0120
.0517
.0910
.1293
.1664
.2019
.2357
.2673
.2967
.3238
.3485
.3708
.3907
.4082
.4236
.4370
.4484
.4582
.4664
.4732
.4788
.4834
.4871
.4901
.4925
.4943
.4957
.4968
.4977
.4983
.4988
.0160
.0557
.0948
.1331
.1700
.2054
.2389
.2704
.2995
.3264
.3508
.3729
.3925
.4099
.4251
.4382
.4495
.4591
.4671
.4738
.4793
.4838
.4875
.4904
.4927
.4945
.4959
.4969
.4977
.4984
.4988
.0199
.0596
.0987
.1368
.1736
.2088
.2422
.2734
.3023
.3289
.3531
.3749
.3944
.4115
.4265
.4394
.4505
.4599
.4678
.4744
.4798
.4842
.4878
.4906
.4929
.4946
.4960
.4970
.4978
.4984
.4989
.0239
.0636
.1026
.1406
.1772
.2123
.2454
.2764
.3051
.3315
.3554
.3770
.3962
.4131
.4279
.4406
.4515
.4608
.4686
.4750
.4803
.4846
.4881
.4909
.4931
.4948
.4961
.4971
.4979
.4985
.4989
.0279
.0675
.1064
.1443
.1808
.2157
.2486
.2794
.3078
.3340
.3577
.3790
.3980
.4147
.4292
.4418
.4525
.4616
.4693
.4756
.4808
.4850
.4884
.4911
.4932
.4949
.4962
.4972
.4979
.4985
.4989
.0319
.0714
.1103
.1480
.1844
.2190
.2517
.2823
.3106
.3365
.3599
.3810
.3997
.4162
.4306
.4429
.4535
.4625
.4699
.4761
.4812
.4854
.4887
.4913
.4934
.4951
.4963
.4973
.4980
.4986
.4990
.0359
.0753
.1141
.1517
.1879
.2224
.2549
.2852
.3133
.3389
.3621
.3830
.4015
.4177
.4319
.4441
.4545
.4633
.4706
.4767
.4817
.4857
.4890
.4916
.4936
.4952
.4964
.4974
.4981
.4986
.4990
Area = 0.4429
P ( 0 < x < 1.58 ) = 0.4429
0
1.58
REGRESSION CORRELATION
Objectives
Relationship between two or more
variables
Scatter diagrams
Regression analysis
Method of least squares
Regression
Definition
Regression Equation
Regression
Definition
Regression Equation
Given a collection of paired data, the regression
equation
y^ = b0 + b1x
algebraically describes the relationship between the
two variables
Regression Line
(line of best fit or least-squares line)
y^ = b0 +b1x
b0 = y - intercept
y = mx +b
b1 = slope
Sample
Statistic
b0
b1
y = 0 + 1 x
^y = b + bx
0
1
Assumptions
1. We are investigating only linear relationships.
2. For each x value, y is a random variable
having a normal (bell-shaped) distribution.
All of these y distributions have the same
variance. Also, for a given value of x, the
distribution of y-values has a mean that lies
on the regression line. (Results are not
seriously affected if departures from normal
distributions and equal variances are not too
extreme.)
Definition
Correlation
exists between two variables
when one of them is related to
the other in some way
Assumptions
1. The sample of paired data (x,y) is a
random sample.
2. The pairs of (x,y) data have a
bivariate normal distribution.
Definition
Scatterplot (or scatter diagram)
is a graph in which the paired (x,y)
sample data are plotted with a
horizontal x axis and a vertical y
axis. Each individual (x,y) pair is
plotted as a single point.
(a) Positive
x
(b) Strong
positive
(c) Perfect
positive
(d) Negative
x
(e) Strong
negative
(f) Perfect
negative
No Linear Correlation
y
x
(g) No Correlation
x
(h) Nonlinear Correlation
TIME SERIES
Objectives
Understanding four components of time
series
Compute seasonal indices
Regression based techniques
Time series
Group of data or statistical information
accumulated at regular intervals
Cyclical fluctuation
The term business cycle or economic cycle refers to the
fluctuations of economic activity (business fluctuations) around
its long-term growth trend. The cycle involves shifts over time
between periods of relatively rapid growth of output (recovery
and prosperity), and periods of relative stagnation or decline
(contraction or recession).
Seasonal variation
Pattern of change within a year
Irregular variation
Unpredictable, changing in a random manner
Trend analysis
To describe historical patterns
Past trends will help us project future
LINEAR PROGRAMMING
Objectives
Understanding Linear programming basics
Graphic and Simplex methods
Linear Programming
Problem formulation if
All equations are linear
Constraints are known and deterministic
Variables should have non negative values
Decision values are also divisible
Types of LP problems
Maximisation
Minimisation
Transportation
Decision making
31.66
33.66
36.66
39.66
31.66
33.66
36.66
39.66
Seasonal components
a. cannot be predicted.
b. are regular repeated patterns.
c. are long runs of observations above or
below the trend line.
d. reflect a shift in the series over time.
Seasonal components
a. cannot be predicted.
b. are regular repeated patterns. *
c. are long runs of observations above or
below the trend line.
d. reflect a shift in the series over time.
Thank You