Mathematical Finance

UNIT VI

Mathematics of Investment

1. Stocks

2. Bonds

3. Mutual Funds

4. Options

5. Cost of Capital and Ratio Analysis

Unit VI Summary

List of Formulas

Exercises for Unit VI

1

Stocks

In addition to their ordinary internal approach to maintaining a solid equity by retaining earnings, business firms, especially large corporations, take an additional external approach to finance their capital needs. To fund their startup operations, maintain their continuous spending, and fund their expansion projects, corporations may raise the needed capital by issuing and selling stocks and bonds. Two major types of securities serve as negotiable instruments of ownership. Investors who are interested in long-term investment buy and sell stocks and bonds in the market and hope to earn money through receiving dividends as their shares of a firm’s profits, as well as through making capital gains when their investment values appreciate. To ensure the safety of their investment and take the best path to earning good returns, investors would have to be studious and smart in following the frequent fluctuations of prices and trends in their stocks and bonds. In this chapter we focus on mathematical operations related to stocks, and continue in the following chapters to address bonds and other types of securities.

For corporations, stocks are a major external source of equity capital that have claims on a firm’s income and assets secondary to claims by their regular business creditors. For an investor, ...