Financial Simulation Modeling in Excel

CHAPTER 1

Introduction

Projecting future performance in finance is rarely an endeavor that will lead to results that exactly mimic reality. Equity products vary as the market evolves, seemingly simple fixed-income products may fluctuate in value due to changing interest rates, and overall most financial products have an ebb and flow of value. None of this is shocking, since much of finance is about the risk of the unknown. Understanding, measuring, and making decisions with future performance risk in mind is the focus of most financial professionals' day-to-day jobs. To understand this risk, models can be built to project what would happen given a set of certain circumstances. Depending on the sophistication of the financial analyst and the level of detail justified for a transaction, a range of techniques are available. The most basic isolated calculations form the starting point for these techniques, which then become more complicated when interconnected concepts are tied together in a deterministic model, and eventually a simulation may be constructed when a simple closed form solution is not appropriate or even possible. This book intends to focus on the last of those three methods, simulation, by taking readers through basic theory and techniques that can be instantly applied to a variety of financial products.