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152 Risk management technology in financial services
If the investor is an insurance company and the security is purchased to back up
pension funds and annuities,
Then the minimum time is very relevant because it indicates that no matter what
the averages say the investment will decay much earlier.
If the sample is large enough to be considered representative of the population
under study, then the distribution plotted against time can give a realistic projection
of the pool’s behaviour keeping in mind that the mortgage with the minimum life
dictates the effective life span of the total distribution as an entity.
8.5 Simulation studies and system engineering
In literature, and in the minds of many people, there is a certain confusion between
the functions of mathematical modelling and simulation on one side, and those of
systems engineering on the other. Therefore, first clarify what is meant by the latter
Dictionaries define engineering as the art and science by which the properties of
matter and source of power in nature are made useful to humanity in structures,
machines and manufactured objects. A system is an assemblage of objects united
by some form of regular interaction and interdependence. In these terms, system
Is the art and science by which nature, men and machines are arranged to form
a working aggregate, creating products and processes from nature’s materials and
energy sources.
The discipline is concerned with analysis and design of productive man/machine
environments, and of their components; as well as of all other systems and com-
ponents which contribute to the conquest of the frontiers of knowledge.
It follows that system engineering has a much broader perspective than modelling and
simulation. In fact, the latter are integral and important parts of the system engineering
effort, particularly welcome as a means to focus the analyst’s or experimenter’s mind.
Simulation is a product that aims to assist the study of other products. Therefore, as
with every other product the system engineer developing a simulator, or conducting
a simulation, acts as a designer. Generally speaking, in approaching industrial and
business problems in one form or another, the designer usually takes the following
steps, some of which are presented in greater detail in Table 8.2:
Regarding the first two bullets, experience shows that problems are very seldom
presented in neat form, with the relevant alternatives identified, the information
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Simulation 153
Table 8.2 Milestone steps in the work of a designer
Understand the problem
Define problem and scope
Undertake initial survey
Develop a mental prototype
Test the original idea(s)
Establish precise requirements
Estimate time and cost
Identify player activities and decision opportunities
Develop an improved mental prototype
Study, organize and structure the prototype
Define specific characteristics
Elaborate the background
Establish constraints
Flesh out the prototype’s first approximation
Study attitudes of end users
Elaborate the information flow
Review goals, workload, deliverables
Make rigorous tests
Edit and streamline the object’s rules
Work on product (or system) design
Define physical and logical characteristics
Outline needed resources
Test design and method with end user(s)
Make necessary modifications and adjustments
Simulate product or system behaviour
Elaborate method of use
Make and test a prototype
Put product or system in use
Critically evaluate deliverables
Establish command and control relationship
Solicit cooperation for feedback
Obtain final approval
Install the new product or system
Follow up and backtest

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