The tools of management science developed specifically for

solving managerial problems are listed below:

 (a) Decision Matrices
• Allocation and investment problems involving
a relatively small number of possible solutions
can be presented in a tabular form known as
decision matrix.
(b) Decision Trees:
The extension of decision matrices for situations involving
several decision periods takes the shape of a tree.
(c) Mathematical Programming:
It attempts to maximize the attainment level of one goal
subject to a set of requirements and limitations. It has
extensive use in business, economics, engineering, the
military and public service, mainly as an aid to the solution of
allocation problems.
(d) Branch and Bound:
It is a step-by-step procedure used when a very large (or even infinite)
number of alternatives exist for certain managerial problems.
(e) Network Models:
This is a family of tools designed for the purpose of planning and
controlling complex projects. The best known models are PERT and CPM.
(f) Dynamic Programming:
It is an approach to decisions that are basically sequential in nature or
can be reformulated so as to be considered sequential. It is a very general
and powerful tool.
(g) Markov Chains:
They are used for predicting the outcome of processes where systems or
units change their condition over time (e.g., consumers change their
preferences for certain brands of commodi­ties).
(h) Game Theory:
It provides a systematic approach to decision-making in
competitive environments and a framework for the study of
conflict.
(i) Inventory Models:
For certain types of inventory control problems, certain models
that attempt to minimize the cost associated with ordering and
carrying inventories have been developed.
(j) Waiting Line (Queuing) Models:
For certain types of problems involving queues, special descriptive
models have been developed to predict the performance of service
systems such as car garages – cars standing in queue for servicing.
(k) Simulation Models:
For the analysis of complex systems when all other models fail,
management science uses descriptive-type simulation models.
 Types of Simulation Models

• 1. Artificial Intelligence.
• 2. Heuristic programming.
• 3. Management games.
• 4. Systems simulation, and
• 5. Monte Carlo simulation.
 Assignment
• In your own point of view is management
science an art or purely science?
• Give the importance of management science
in modern management
• Is management science evolving among
Asian managers today? Why?
• Explain the following models mentioned
above.
 Management Science
Standard mathematical techniques and problem
structuring methods are essential in managerial
decision-making. Accounting students must master the
use of these techniques to help them in their future
role as business leaders. This course equips the learners
with skills on linear programming applications, solution
and sensitivity analysis using spreadsheets, distribution
and network models, project scheduling, integer linear
programming, forecasting, decision analysis, queuing
models, and simulations.
 Management Science Defined
• Management science (MS) is the broad
interdisciplinary study of problem solving and
decision making in human organizations, with
strong links to management, economics,
business,
engineering, management consulting, and
other fields. ... Management science helps
businesses to achieve goals using
various scientific methods.
 Is management science or art?

• Management can be considered as

both science as well as an art. ... It is
considered as a science because it has an
organized body of knowledge which contains
certain universal truth. It is called an art
because managing requires certain skills which
are personal possessions of managers.
 Continue…
• Management is science because of several
reasons—it has universally accepted
principles, it has cause and effect relationship,
etc, and at the same time it is art as it requires
perfection through practice, practical
knowledge, creativity, personal skills,
etc. Management is both art and science
What is the importance of management?

• It helps in Achieving Group Goals - It arranges

the factors of production, assembles and
organizes the resources, integrates the
resources in effective manner to achieve
goals. It directs group efforts towards
achievement of pre-determined goals.
 Scope of Management Science
• Management is considered as a continuing
activity made up of
basic management functions like planning,
organizing, staffing, directing and controlling.
These components form the subject-matter
of management.
 Artificial Intelligence Modeling Simulation

• AI is the field of computer science that attempts to construct computer

systems that emulate human problem solving behavior with the goal of
understanding human intelligence. M&S is a multidisciplinary field of
systems engineering, software engineering, and computer science that
seeks to develop robust methodologies for constructing computerized
models with the goal of providing tools that can assist humans in all
activities of the M&S enterprise. Although each of these disciplines has its
core community there have been numerous intersections and cross‐
fertilizations between the two fields. From the perspective of this article,
we view M&S as presenting some fundamental and very difficult problems
whose solution may benefit from the concepts and techniques of AI.
 Heuristic programming.
• Heuristics are a problem-solving method that
uses shortcuts to produce good-enough
solutions given a limited time frame or
deadline. Heuristics are a flexibility technique
for quick decisions, particularly when working
with complex data. Decisions made using
an heuristic approach may not necessarily be
optimal.
 What is heuristic

Heuristics can be mental shortcuts that

ease the cognitive load of making a
decision. ... Examples that
employ heuristics include using trial
and error, a rule of thumb or an
educated guess.
 Management games.
• Deep actionable knowledge and decision-
making skills develop when people have the
chance to apply classroom theory in the real
world, with its messy complexity, time
pressures, and irreversible consequences.”
• Management simulation games bring an
experiential aspect to learning about complex
systems. This type of action learning has more
impact on students than simply listening to a
lecture or engaging in a case study discussion.
Students who participate in a simulation can see
the immediate consequences of their decisions
and learn what it’s truly like to juggle competing
priorities amidst a constant influx of information.
 Systems simulation
• Systems simulation is a set of techniques that uses
computers to imitate the operations of various real-
world tasks or processes through simulation. Computers
are used to generate numeric models for the purpose of
describing or displaying complex interaction among
multiple variables within a system. The complexity of
the system arises from the stochastic (probabilistic)
nature of the events, rules for the interaction of the
elements and the difficulty in perceiving the behavior of
the systems as a whole with the passing of time.
 Monte Carlo simulation
• Monte Carlo simulation is a computerized
mathematical technique that allows people to
account for risk in quantitative analysis and
decision making. The technique is used by
professionals in such widely disparate fields as
finance, project management, energy,
manufacturing, engineering, research and
development, insurance, oil & gas,
transportation, and the environment.
• Monte Carlo simulation furnishes the
decision-maker with a range of possible
outcomes and the probabilities they will occur
for any choice of action. It shows the extreme
possibilities—the outcomes of going for broke
and for the most conservative decision—along
with all possible consequences for middle-of-
the-road decisions.
Monte Carlo methods, or Monte Carlo
experiments, are a broad class of
computational algorithms that rely on
repeated random sampling to obtain
numerical results. The underlying
concept is to use randomness to solve
problems that might be deterministic in
principle.
 After the qualitative decision making
approach…
• Managers may opt to utilize
quantitative decision making
method. The following are few
among the most popular way of
quantitative decision making
approach.
 Sensitivity analysis
• Sensitivity analysis is the quantitative risk
assessment of how changes in a specific
model variable impacts the output of the
model. ... For example, sensitivity
analysis allows you to identify which task's
duration with uncertainty has the strongest
correlation with the finish time of the project.
 example
• One simple example of sensitivity
analysis used in business is an analysis of the
effect of including a certain piece of
information in a company's advertising,
comparing sales results from ads that differ
only in whether or not they include the
specific piece of information.
• Sensitivity Analysis is used to understand the
effect of a set of independent variables on
some dependent variable under certain
specific conditions. For example, a financial
analyst wants to find out the effect of a
company's net working capital on its profit
margin.
 Use of sensitivity analysis
• sensitivity analysis determines how different
values of an independent variable affect a
particular dependent variable under a given
set of assumptions. In other words, sensitivity
analyses study how various sources of
uncertainty in a mathematical model
contribute to the model's overall uncertainty.
 Uses of Sensitivity Analysis

• Here we discuss the uses of sensitivity analysis:

• Developing Recommendations for the Decision-makers
• Feasibility testing of an optimal solution
• Identifying the sensitive variables
• Identifying critical values and break-even point where the
optimal strategy changes
• Assessing the degree of risk involved in strategy or
scenario
• Communication
• Allows the decision-makers to make assumptions
• Making recommendations
• Quantifying the parameters
• Developing a hypothesis for testing different scenarios
• Estimating the requirements of the input and output variables
• Understanding the relationship between input variables and
the outcome
• Forms of Outcomes in Sensitivity Analysis:
• Pessimistic
• Expected or the Original
• Optimistic
Decision Making with Probabilities
• For the expected value approach, determine
the probabilities for each of the state-of-
nature branches. ... Select the decision branch
leading to the state-of-nature node with the
best (highest) expected value.
The decision alternative associated with this
branch is the recommended decision.
 What is expected value approach
• The expected value (EV) is an
anticipated value for an investment at some
point in the future. In statistics and probability
analysis, the expected value is calculated by
multiplying each of the possible outcomes by
the likelihood each outcome will occur and
then summing all of those values.
 How is probability applied in decision
making?
• You can calculate the probability that an
event will happen by dividing the number of
ways that the event can happen by the
number of total possibilities. Probability
can help you to make better decisions, such as
deciding whether or not to play a game where
the outcome may not be immediately obvious.
 Information needed to compute expected
value analysis

• An expected value analysis requires the

following information: 1) Number of
alternatives present in the analysis. 2)
Number of states of nature for each of the
alternatives. 3) The expected payoff for each
of these states of nature for each of the
alternatives.
 Importance of probability?
• Probability is an essential tool in applied
mathematics and mathematical modeling. ... It
is vital to have an understanding of the nature
of chance and variation in life, in order to be a
well-informed, (or “efficient”) citizen. One
area in which this is extremely important is in
understanding risk and relative risk.
 How to compute probability?
• Calculating probability requires following a simple formula
and using multiplication and division to evaluate possible
outcomes of events like launching new products, marketing
to larger audiences or developing a new lead generation
strategy. You can use the following steps to calculate
probability, and this can work for many applications that fall
under a probability format:
• Determine a single event with a single outcome
• Identify the total number of outcomes that can occur
• Divide the number of events by the number of possible
outcomes
 Example
• For instance, rolling a die once and landing on a three
can be considered one event. You can continue to roll
the die, however, and each time you roll would be a
single event.
• So in the case of this example, you would divide the
one event by the six possible outcomes that could
occur. This results in a fraction: 1/6. So the probability
that you will roll a three on the first try is one in six.
You can further calculate the odds that you will roll a
three on the first try by using the probability.
 Odds VS Probability
• Probability differs from determining the odds of
something occurring. To help illustrate this concept, use
the example of calculating the probability of rolling a
die and getting a three on the first roll. You first
determine the event you are looking for, which is rolling
a three on the first try, and then you divide this number
by the number of total outcomes you can get. Since the
die has six faces, you can assume that you can have six
total possible outcomes. So the probability will be one
in six or a 1/6 chance of rolling a three on the first try.
 Odds VS Probability
• Determining the likelihood of this event
actually occurring is referred to as the odds.
The odds, or chance, of something happening
depends on the probability. Probability
represents the likelihood of an event occurring
for a fraction of the number of times you test
the outcome. The odds take the probability of
an event occurring and divide it by the
probability of the event not occurring.
 Odds VS Probability
• So in the case of rolling a three on the first try, the
probability is 1/6 that you will roll a three, while the
probability that you won't roll a three is 5/6. The
odds are represented by dividing these two
probabilities: 1/6 ÷ 5/6 resulting in a 1/5 (or 20%)
chance that you will actually roll a three on the first
try. While the two mathematical concepts can be
used together to solve various problems, you will
need to calculate probability before determining
the odds of an event taking place.
 How to calculate probability with multiple random
events

• Calculating probability with multiple random

events is similar to calculating probability with a
single event, however, there are several
additional steps to reach a final solution. The
following steps outline how to calculate the
probability of multiple events:
• Determine each event you will calculate
• Calculate the probability of each event
• Multiply all probabilities together
 example
• Using the dice example, you would
calculate your total probability by
multiplying the 1/6 chances you
calculated in step two. Since each event
has a 1/6 chance of happening, you need
to multiply 1/6 x 1/6 to get a 1/36
chance of rolling a six on one die at the
same time you roll a six with the other.
 Decision Theory: Expected Value Analysis

• In discussing Decision Models , we broke down

how to think about a decisions and the options
you can choose between. In many ways, even
more important than the options you choose
between are the eventual outcomes of those
choices.
• For example, let’s say you are trying to decide
if you should buy a lottery ticket. We can
model the decision as follows:
Example
 Take note
• Looking at the decision there, obviously we should buy the
ticket! However, what we haven’t captured is that the
probability of winning is not 100%. In fact, for most lotteries the
probability of winning is extraordinarily small. Let us assume
the probability of winning this lottery is 1 in 175 million (typical
for the Powerball). How then do we measure the value of that
potential outcome?
• Expected values are a way of evaluating outcomes that are
subject to probability (also known as random variables). The
expected value allows you to take into account the likelihood of
event when quantifying it, and compare it with other events of
differing probabilities.
To calculate an expected value, you multiply the
probability of the event by the value of the event. In
this case, we multiply the value of winning ($100M)
with the probability of winning:
• It is a situation similar to “what-if” analysis or
the use of simulation analysis. It is used to
predict the outcome of a decision based on a
certain range of variables. It is especially very
useful in cases where investors and stake-
holders are evaluating the projects and
proposals from the same industry or from
different industries but driven by similar
factors.
• In simple terms, the payoff for
winning is huge but the chances
of winning are tiny so the
expected value of buying a ticket
is only 57 cents.
We can now use this in our decision model
to make the decision clear:
 Therefore….
• Now the choice is clear, we are much better to not
buy the ticket and save our $1 than buy the ticket
and lose $0.43! This is the power of expected values,
they allow us to quickly and easily account for
probabilities when comparing options.
• Of course, most decisions will include many different
probabilities. Tomorrow we’ll cover multi-stage
decisions where one decision may lead to many
others, and bring together what we’ve discussed so
far to make some actual decisions!
 portfolio
• A portfolio refers to a collection of
investment tools such as stocks,
shares, mutual funds, bonds, cash
and so on depending on the
investor’s income, budget and
convenient time frame.
 Portfolio Management
• Portfolio Management is defined as the art
and science of making decisions about the
investment mix and policy, matching
investments to objectives, asset allocation for
individuals and institutions, and balancing risk
against performance. (Source: Investopedia).
 Therefore

• The art of selecting the right investment policy for the individuals
in terms of minimum risk and maximum return is called as
portfolio management.
• Portfolio management refers to managing an individual’s
investments in the form of bonds, shares, cash, mutual funds etc
so that he earns the maximum profits within the stipulated time
frame.
• Portfolio management refers to managing money of an individual
under the expert guidance of portfolio managers.
• In a layman’s language, the art of managing an individual’s
investment is called as portfolio management.
 Need for Portfolio Management

• Portfolio management presents the best investment plan to

the individuals as per their income, budget, age and ability to
undertake risks.
• Portfolio management minimizes the risks involved in
investing and also increases the chance of making profits.
• Portfolio managers understand the client’s financial needs
and suggest the best and unique investment policy for them
with minimum risks involved.
• Portfolio management enables the portfolio managers
to provide customized investment solutions to clients as per
their needs and requirements.
 Types of Portfolio Management

• Active Portfolio Management: As the name

suggests, in an active portfolio management service,
the portfolio managers are actively involved in buying
and selling of securities to ensure maximum profits
to individuals.
• Passive Portfolio Management: In a passive portfolio
management, the portfolio manager deals with a
fixed portfolio designed to match the current market
scenario.
 Types of Portfolio Management

• Discretionary Portfolio management services: In Discretionary

portfolio management services, an individual authorizes a
portfolio manager to take care of his financial needs on his
behalf. The individual issues money to the portfolio manager
who in turn takes care of all his investment needs, paper work,
documentation, filing and so on. In discretionary portfolio
management, the portfolio manager has full rights to take
decisions on his client’s behalf.
• Non-Discretionary Portfolio management services: In non
discretionary portfolio management services, the portfolio
manager can merely advise the client what is good and bad for
him but the client reserves full right to take his own decisions.
 Who is a Portfolio Manager ?

• An individual who understands the client’s financial needs and designs a

suitable investment plan as per his income and risk taking abilities is called a
portfolio manager. A portfolio manager is one who invests on behalf of the
client.

• A portfolio manager counsels the clients and advises him the best possible
investment plan which would guarantee maximum returns to the individual.

• A portfolio manager must understand the client’s financial goals and

objectives and offer a tailor made investment solution to him. No two clients
can have the same financial needs.
• Diversification can help an
investor manage risk and reduce the volatility
of an asset's price movements. ... You can
reduce the risk associated with individual
stocks, but general market risks affect nearly
every stock and so it is also important
to diversify among different asset classes
• A company spreads its risks by selling a varied
product range, operating in different markets,
or selling in many countries. Investors create
a diversified portfolio of assets, so
specific risk associated with one asset is offset
by the specific risk associated with another
asset.
• Diversification is the practice of spreading
your investments around so that your
exposure to any one type of asset is limited.
This practice is designed to help reduce the
volatility of your portfolio over time. ... One
way to balance risk and reward in your
investment portfolio is to diversify your
assets.
The benefits of diversification include:

• Minimizes the risk of loss to your overall

portfolio.
• Exposes you to more opportunities for return.
• Safeguards you against adverse market cycles.
• Reduces volatility.
 Is diversification good or bad?
• Diversification can lead into poor
performance, more risk and higher investment
fees! ... The usual message to investors is:
instead of diversifying from traditional stocks
& bonds, diversify into multiple higher-cost
exchange-traded funds that invest in specific
sectors or strategies.
• A positive correlation exists between risk and
return: the greater the risk, the higher the
potential for profit or loss. Using the risk-
reward tradeoff principle, low levels of
uncertainty (risk) are associated with low
returns and high levels of uncertainty with
high returns.
 Risk and investment
• The risk associated with investments can be
thought of as lying along a spectrum. On the
low-risk end, there are short-term
government bonds with low yields. The
middle of the spectrum may contain
investments such as rental property or high-
yield debt. On the high-risk end of the
spectrum are equity investments, futures and
commodity contracts, including options.
 further
• Investments with different levels of risk are often
placed together in a portfolio to maximize returns
while minimizing the possibility of volatility and
loss. Modern portfolio theory (MPT) uses statistical
techniques to determine an efficient frontier that
results in the lowest risk for a given rate of return.
Using the concepts of this theory, assets are
combined in a portfolio based on statistical
measurements such as standard deviation and
correlation.
 The Risk-Return Tradeoff
• The correlation between the hazards one runs in
investing and the performance of investments is
known as the risk-return tradeoff. The risk-return
tradeoff states the higher the risk, the higher the
reward—and vice versa. Using this principle, low levels
of uncertainty (risk) are associated with low potential
returns and high levels of uncertainty with high
potential returns. According to the risk-return tradeoff,
invested money can render higher profits only if the
investor will accept a higher possibility of losses.
 Risk Tolerance

• An investor needs to understand his individual

risk tolerance when constructing a portfolio of assets.
Risk tolerance varies among investors. Factors that
impact risk tolerance may include:
• the amount of time remaining until retirement
• the size of the portfolio
• future earnings potential
• ability to replace lost funds
• the presence of other types of assets: equity in a home,
a pension plan, an insurance policy
 Managing Risk and Return

• Formulas, strategies, and algorithms abound that are

dedicated to analyzing and attempting to quantify
the relationship between risk and return.
• Roy's safety-first criterion, also known as the SFRatio,
is an approach to investment decisions that sets a
minimum required return for a given level of risk. Its
formula provides a probability of getting a minimum-
required return on a portfolio; an investor's optimal
decision is to choose the portfolio with the highest
SFRatio.
• Another popular measure is the Sharpe ratio.
This calculation compares an asset's, fund's, or
portfolio's return to the performance of a risk-
free investment, most commonly the three-
month U.S. Treasury bill. The greater the
Sharpe ratio, the better the risk-adjusted
performance.
 Related Terms

• Risk-Seeking Risk-seeking is an acceptance of more economic uncertainty in exchange

for potentially higher returns.
• more
• Risk Risk takes on many forms but is broadly categorized as the chance an outcome or
investment's actual return will differ from the expected outcome or return.

• Risk-Return Tradeoff Risk-return tradeoff is a fundamental trading principle

describing the inverse relationship between investment risk and investment return.

• Investment Pyramid Definition An investment pyramid is a strategy used by investors

by layering smaller weights of more risky assets on top of larger allocations to more
conservative assets.

• How to Use the Sharpe Ratio to Analyze Portfolio Risk and ReturnThe Sharpe ratio is
used to help investors understand the return of an investment compared to its risk.