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Calculus and its applications

Dr. Ramdas B. Sonawane1

1
Ness Wadia College of Commerce, Pune
Dr. Ramdas B. Sonawane Calculus and its applications
What is Calculus?

Calculus is a branch of mathematics in which the focus is on


two main things: given a real-valued function of a real
variable, what is the rate of change of the function at a point
(Differentiation), and what is the area under the graph of the
function over an interval (Integration).

Dr. Ramdas B. Sonawane Calculus and its applications


What is Calculus?

Dr. Ramdas B. Sonawane Calculus and its applications


What is Calculus?

Dr. Ramdas B. Sonawane Calculus and its applications


Why study Calculus?
Calculus is a part of all scientific undergraduate education
because it is universally applicable in Physics, Engineering,
Biology, Economics, and so on. For example:
1. What is the escape velocity of a rocket on the surface of
the Earth?
2. If a hole of radius 1 cm is drilled along a diametrical axis
in a solid sphere of radius 2 cm, then what is the volume
of the body left over?
3. If a strain of bacteria grows at a rate proportional to the
amount present, and if the population doubles in an hour,
then what is the population of bacteria at any time t?
4. If the manufacturing cost of x lamps is given by
C (x) = 2700 100x, and the revenue function is given
by R(x) = x 0.03x 2 , then what is the number of lamps
maximizing the profit?
Dr. Ramdas B. Sonawane Calculus and its applications
Portfolio Problem
Suppose a person has some wealth. He wants to invest it and
earn. There are many ways, he do it. He can invest it in real
estate, can purchase gold, can deposit in banks, invest in
stock market etc. He can gain highest returns from stock
market. There are many kinds of information that might be
used to predict the performance of stocks: general economic
conditions, health of industry which the stock represents,
productivity of the company as reflected in its annual report,
success of the companys competitors, and so on. Here we will
study the approach using stock quotations and some statistics
to define and estimate average rate of return on investment
and the risk of investment. We use the technique of Lagrange
multipliers to put together an optimal portfolio to investment.
The problem of choosing an optimal combination of
investments is known as the Portfolio Problem.
Dr. Ramdas B. Sonawane Calculus and its applications
Portfolio Problem
Suppose that we are following four possible investments,
whose market prices per share today are P1 , P2 , P3 and P4 .
Let the prices for the same stocks tomorrow be denoted by
Q1 , Q2 , Q3 and Q4 .
The rate of return on the investment, that is the gain in value
per rupee paid on stock i, is
Qi Pi
Ri = .
Pi
For example we have recorded the prices of the common
stocks of four companies trading on the Bombay Stock
Exchange. We followed the stocks over a period of seventeen
trading days. The numbers in the rate of return columns are
obtained by dividing the difference (current price minus
previous price) by the previous price. Taking the arithmetical
average of those observed rates of return gives the estimates
of , , , and listed
Dr. Ramdas in the Calculus
B. Sonawane row labeled Mean.
and its applications
Portfolio Problem

Dr. Ramdas B. Sonawane Calculus and its applications


Portfolio Problem

Table suggests that there is variability in the rates of return.


Typically, risky investments which have high average rates of
return also have high risks. If this is not the case, the investors
will all flock to high-reward, low-risk investments, and market
imbalances will occur. To increase safety, investors tend to
diversify, that is, to spread their wealth among several
opportunities, hence constructing a collection of portfolio of
investments. Suppose the investor has total wealth W , then
the decision to be made is what fraction wi of that wealth is
to be devoted to investment i, for i = 1, 2, 3, 4. The total
wealth invested in investment i is wi W , and as the expected
rate of return per rupee invested is i , the expected return
from our investment in investment i is i wi W .

Dr. Ramdas B. Sonawane Calculus and its applications


Portfolio Problem
Summing over all four investments, the total return expected is
1 w1 W + 2 w2 W + 3 w3 W + 4 w4 W .
Since we invested W rupees, the rate of return for the
portfolio per rupee is
1 w1 W + 2 w2 W + 3 w3 W + 4 w4 W
= .
W
That is,
= 1 w1 + 2 w2 + 3 w3 + 4 w4 .
The variance Var (R) = 2 of an uncertain rate of return is the
average squared difference between the rate of return R and its
mean . In the portfolio problem we will need to consider the
risk or variance of the portfolios actual rate of return, which is
Rp = R1 w1 + R2 w2 + R3 w3 + R4 w4 .
Dr. Ramdas B. Sonawane Calculus and its applications
Portfolio Problem
Thus,
Var (Rp ) = Var (R1 w1 + R2 w2 + R3 w3 + R4 w4 ).
That is,
Var (Rp ) = 12 w12 + 22 w22 + 32 w32 + 42 w42 .
We have to maximize, a 2 , where a is a risk aversion
factor which measures the reluctance to take risk. For example
a = 0 means that you dont mind taking risk at all, your only
goal is to maximize average rate of return. If a = 10, then an
increase of one unit in risk will have to be offset by an increase
in 10 units of return in order to value the investment in the
same way. A larger value of a means more worry about risk.
Now we are having the portfolio problem which is the
constrained optimization problem.
Dr. Ramdas B. Sonawane Calculus and its applications
Portfolio Problem

Maximize f (w1 , w2 , w3 , w4 ) = 1 w1 + 2 w2 + 3 w3 + 4 w4
a(12 w12 + 22 w22 + 32 w32 + 42 w42 )
subject to g (w1 , w2 , w3 , w4 ) = w1 + w2 + w3 + w4 1 = 0.

Using Lagranges multiplier method we get a system of


equations in the unknowns , w1 , w2 , w3 and w4 :

1 2a12 w1 = ,
2 2a22 w2 = ,
3 2a32 w3 = ,
4 2a42 w4 = ,
w1 + w2 + w3 + w4 = 1.

Dr. Ramdas B. Sonawane Calculus and its applications


Portfolio Problem
From these equations we get values of w2 , w3 and w4 in terms
of w1 as follows:
(2 1 )+2a12 w1
w2 = 2a22
,
(3 1 )+2a12 w1
w3 = 2a32
,
(4 1 )+2a12 w1
w4 = 2a42
.

Thus (2 1 ) ( ) ( )
1 3 21 4 21
2a 2 2a 2a
w1 = 2
2 2
3
2
4
.
1+ 12 + 12 + 12

2 3 4

Similarly we get values of w2 , w3 and w4 . Numerical


computations for several values of risk aversion a and mean
and variances from table 1, results in the following solution:
Dr. Ramdas B. Sonawane Calculus and its applications
Portfolio Problem

Dr. Ramdas B. Sonawane Calculus and its applications


Thank You

Dr. Ramdas B. Sonawane Calculus and its applications

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