Let’s see what

we did in the
previous class!!!
 Prof. C. P. Gupta
Department of Financial Studies
So… we started our journey
With a note that … it is a skilled based
Course!!!
We tried to understand the Basic pedagogy adopted for
the Course…
Find a solution for the
model!!!!

It is a
matter of
Technique!

Modeling is a
matter of ART and
SKILL!!!
We started the course with Matrices …
We covered in the previous class…

• Meaning and Types of matrices.

• Basic Operations related to Matrices.

• Determinants

• Linear Equations

• Solving System of Linear Equations

That
That was
was aa QUICK
QUICK
RECAP
RECAP ofof our
our
Mathematical
Mathematical
concepts
concepts related
related to
to
matrices
matrices and
and system
system
of
of linear
linear equations!!!!!
equations!!!!!
Now,
Now, let’s
let’s try
try to
to implement
implement
them
them through
through EXCEL
EXCEL
NAMING cells in EXCEL to make things
efficient!!!!

• Cells in EXCEL can be named and accordingly

referred.

Trying to learn ‘HOW?’

Once naming of the Cell is being done…

• …we can take some exercises in matrices and try to

solve them through EXCEL.
 Exercise #1…

1.Consider the following matrices:

é1 3 ù é3 7 ù
é5 -4ù
A = ê0 2ú B = ê8 5 ú C =
ê8 1 ú
ê ú ê ú ë û
êë4 8úû êë4 -2úû

Using EXCEL, evaluate the following:

a. A+B
b. A-B
c. (Transpose of A)B
d. BC
e. C-1
 Exercise #2…

1. A salesman’s expense account for the first week of a certain month has the daily
expenses (in hundreds of Rs.) shown in the following table:

Meals Lodging Travel Other

Monday 22 40 100 5
Tuesday 20 40 20 0
Wednesday 28 70 45 0
Thursday 15 70 20 10
Friday 20 0 100 0

(a) The salesman finds that his expenses for the second week are 5% more (in each
category) than for the first week. Find his expense matrix for the second week.
(b) Find the total expenses for the first week under each head as well as grand total.
 Exercise #3…

1.A firm produces three products A, B and C which it sells in two

markets. Annual sales in units and other details are given below:

Units Sold
A B C
Market – I 8000 4000 16000
Market – II 7000 18000 9000

Price (Per Unit) Rs. 25 Rs. 12.50 Rs. 15

Cost (Per Unit) Rs. 17 Rs. 12 Rs. 8

Use matrices and determine the profit amount for each product in both
the markets, for each market for all the products and then, overall total
profit.
 Exercise #4…

Precision Tools and Machines are producing three products – P1, P2

and P3 through one production department (P) and two service
centers – S1 and S2. The following data is available about them:

Hours required to produce a unit in

Products P S1 S2

P1 2 5 1
P2 1 2 3
P3 2 2 3
Maximum time 1100 1800 1400
available (in Hours)
Find the number of units of P1, P2 and P3 to be
produced if the full capacity is to be used.
 Exercise #5…

A salesman has the following record of sales during the previous

three months for three items A, B and C; and all the three items have
different commission rates.

Sales (Units)
Months, 2010 A B C

April 90 100 20
May 150 50 40
June
Total commission for the60 100
months of April, May and30June was
Rs. 800, 900 and 850. Use matrices and find the rates of
commission for the items.
 Exercise #6…

Mr. Suresh Khanna had Rs. 35 lakhs that he invested in a saving

bank account earning 6% pa, in bonds earning a yield of 7%, and the
reminder in his own business. During 2009-10, his total earnings
from investment was Rs. 66,000 even though, he lost 6% of money
invested in his own business. He had invested Rs. 3 lakhs more in
the business than in his saving bank account. Determine the amounts
he had invested in each.
 Exercise #7…

A dietician is planning diet schedule for a patient and this diet will be
a combination of the Food Items – I, II and III. The vitamin contents
in each food item (per unit) are given in the table below:

Vitamin (Units)
Food Items A B C

Food-I 3 9 12
Food-II 6 9 15
Food-III 9 0 9
You are required to determine the units of these three food
items in the combined diet such that the resultant diet should
have 33 units of vitamin A, 27 units of vitamin B, and 60 units
of vitamin C.
 Exercise #8…

Three companies X, Y and Z holds shares in each other. The

ownership of the three companies are given below:
Percent of share capital held in a company
Owners of shares X Y Z

X 0 30 20
Y 30 0 10
Z 10 20 0
Others 60 50 70
Total 100 100 100
If the profits earned by X, Y and Z during 2009-10 are Rs. 53
crores, Rs. 4 crores and Rs. 140 crores, use matrices and
determine the total profit earned by each company including
the share in other companies.
1.Limits
2.Continuity
3.Differential Calculus
LIMITS…
Limit of a function…

• The limit of a function is a concept concerning the behavior of

a function near a particular input.

• A function f assigns an output f(x) to every input x. The function

has a limit L at an input p if f(x) is "close" to L whenever x is
"close" to p.

• Or, f(x) becomes closer and closer to L as x moves closer and closer

to p.

• More specifically, when f is applied to each input sufficiently close

to p, the result is an output value that is arbitrarily close to L.

• If the inputs "close" to p are taken to values that are very different,
the limit is said to not exist.
Formal Definition of Limit…

• Suppose f : R → R is defined on the real line and p,

L ∈ R then we say the limit of f as x approaches p is
L and write -

– if and only if for every real ε > 0 there exists

a real δ > 0 such that 0 < | x - p | < δ implies |
f(x) - L| < ε.

• Note that the value of the limit does not depend on

the value of f(p).
Formal Definition of Limit…

• Suppose f : R → R is defined on the real line and p,

L ∈ R then we say the limit of f as x approaches p is
L and write -

– if and only if for every real ε > 0 there exists

a real δ > 0 such that 0 < | x - p | < δ implies |
f(x) - L| < ε.

• Note that the value of the limit does not depend on

the value of f(p).
Properties of Limit…

• If f is a real-valued function, then taking the limit is

compatible with the algebraic operations, provided the
limits on the right sides of the equations below exist (the
last identity only holds if the denominator is non-zero).
This fact is often called the Algebraic Limit Theorem.
Indeterminate Forms of limits…

• In situations where limiting values are taking forms

that are meaningless such as –
– 0/0;
 /;
– 0/;
– 0×;

• Such forms are called Indeterminate Forms.

Please note that…

• …the following important limits:

n
æ 1ö
1. lim ç1 + ÷ = e
n® ¥ è n ø

n
æ x ö x
2. lim ç1 + ÷ = e
n® ¥ è n ø
It’s
It’s time
time to
to apply
apply the
the
concept
concept ofof LIMIT!!!
LIMIT!!!
Application #1:

• Derive the formula for Continuous Compounding of

Principal Amount using the idea of LIMIT!!!!
Application #2:

• If MR = AR(1-1/nd) where MR = Marginal

Revenue, AR= Average Revenue and nd
is price elasticity of demand. Determine
the limit of MR if elasticity of demand
tends to infinity. Provide also the
necessary interpretation of the same.
Application #3:

• For the demand function p = a/(x+b)

where p = price, x= demand and a & b
are constants. Show by using the
concept of limit that as price tends to
zero, demand for the product tends to
infinity.
Now,
Now, let’s
let’s move
move to
to …
…

……CONTINUITY
CONTINUITY…

• Intuitively, the idea of continuity is given by the common statement

that a continuous function is a function whose graph can be drawn
without lifting the chalk from the blackboard; or can be traced
without lifting the pencil on the graph of the function.

• A function f(x) is said to be continuous at a point x = c if the

following three conditions for continuity of f(x) at a point x
= c are satisfied:
a. The function must be defined at c, or f(c) must exist.
b. lim f(x) must exist; and
xc

c. lim f(x) = f(c).

x c
Application of Continuity…

• A firm has four plants and operates them as they

are needed. Each plant has a fixed cost of Rs.
3,000 per month whether operating or not. In
addition, each plant if in operation will incur an
additional fixed cost of Rs. 5,000 per month. The
raw material cost per unit is Rs. 5 per unit of
output. Each plant can produce at the most
10,000 units of output per month. Find the total
cost function and examine the points of
discontinuity thereof.
Application of Calculus - #1

Total cost C(x) of a firm is given by,

C(x) = 20 + 2x + 0.5x2,
in terms of the output x. Determine-
1. Average Cost
2. Rate of Change in Average Cost
3. Marginal Cost
4. Rate of Change in the Marginal Cost
Application of Calculus - #2

The demand x (in Kg) for a commodity when its

price p is given by p = 108-3x/5.
Determine-
1. Average Revenue
2. Rate of Change in Average Revenue
3. Marginal Revenue
4. Rate of Change in the Marginal Revenue
 Application
Application of
of calculus
calculus to
to
the
the Bond
Bond Valuation…
Valuation…
…Before we apply calculus to Bonds, let’s spend few
minutes on understanding of valuation of a bond!!!!
How
How do
do we
we decide
decide that
that …
…
“What price one should
pay for a bond?”
 HOW TO VALUE A BOND?

• The value of a bond should be equal to the sum of the present

values of future cashflows coming from a bond.

c1 c2 c n  RV
P    ... 
(1  r )1 (1  r )2 (1  r )n
where
P  price of bond
ci  coupon of ith period
RV  redemption value
r  discount rate or YTM
Relation
Relation between
between BOND
BOND PRICES
PRICES
and
and YIELD-TO-MATURITY
YIELD-TO-MATURITY
…can be depicted by the graph…
 RELATION BETWEEN BOND VALUATION AND BOND YIELD
700

600 Use Calculus and show

why there is a Negative
500
Relation between Bond
Price and Yield.
PRICE (Rs.)

400

300

200

100

0
1% 7% 13% 20% 30% 50%
YIELD
Further,
Further, the
the Relation
Relation between
between
BOND
BOND PRICES
PRICES and
and YIELD-TO-
YIELD-TO-
MATURITY
MATURITY is is CONVEX
CONVEX … …

…as depicted by the graph…

 RELATION BETWEEN BOND VALUATION AND BOND YIELD
700

Use Calculus and

600
show why there is a
GAINS BECOME CONVEX Relation
500 GREATER!!
between Bond Price
and Yield.
PRICE (Rs.)

400

300 CONVEX SHAPE OF

THE CURVE

200

LOSSES
100 BECOME
SMALLER!!

0
1% 7% 13% 20% 30% 50%
YIELD
Now,
Now, let
let use
use the
the concept
concept of
of
Concave
Concave Function
Function to
to define
define aa
concept
concept ofof Risk
Risk Averse!!!!
Averse!!!!
 Risk Averse …

• An investor is Risk Averse if he or she

demands more and more for additional unit of
risk.

• Such a person is characterized by CONCAVE

UTILITY FUNCTION.
 The
The next
next task
task is
is …Using
…Using
Taylor’s
Taylor’s Series
Series for
for
Forecasting
Forecasting Bond
Bond Prices!!!!
Prices!!!!
 Taylor’s Series …

• A function can be expanded around a value x0 as

thus:
'' 2 ''' 3
f ( x )( x - x ) f ( x )( x - x )
f ( x) = f ( x0 ) + f ' ( x0 )( x - x0 ) + 0 0
+ 0 0
+ ...
2! 3!

• Using the above Taylor Series upto second

derivative, develop a bond price predictive model
that can provide fairly good approximation.
Show
Show how
how it
it can
can be
be used
used to
to
Predict
Predict BOND
BOND PRICES?
PRICES?