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Financial modeling - Essay Example

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But this is not to say that financial modeling cannot be performed manually.There are various financial models that a company can use in evaluating its investment projects. The only challenge for the company is to identify the model that will provide the most accurate information that can help the company make the right decision.With the advent of technology and computer, many models nowadays are calculated and evaluated using computer software which makes the whole process easy and faster. It is a fact that in a competitive world, companies should be able to make fast, timely and accurate investment decisions. But this is not to say that financial modeling cannot be performed manually.There are various financial models that a company can use in evaluating its investment projects. The only challenge for the company is to identify the model that will provide the most accurate information that can help the company make the right decision.Some of there models include Value- at- risk models, Interest rate models, Equity pricing models, Asset allocation models, Trading models, Investment portfolio models that can be used on equity or derivatives, Business simulation models that include Monte Carlo simulation and binary free and genetic algorithms used in optimization decisions.This is a model of calculating the probability of a collection of investment securities generating returns more than the anticipated. It is a model of analyzing past market performance, security correlation and the security movements.
A basic value-at-risk model involves all types of market uncertainties e.g. interest, stock, goods and currency risks. It enables the determination of an estimate on the value of portfolio risk (maximum loss) based on the past performance of the portfolio at a given rate of certainty.
The various models under the value-at-risk include the variance-covariance method, historical simulation and Monte Carlo simulation models.
Variance-covariance
It uses past values of security movements and relationship to determine the estimate of the future loses that could occur. Security movements and security relationship risk is calculated for a given period of time.
Historical simulation models
It generates a lot of results of the security value. It uses security risk and their associated probabilities to generate these results which are used to estimate the value of VaR.
Interest rate models
Some of the most commonly used interest rate financial models are the Black-Derman-Toy (BDT) model, Black -Karainsky (BK) model, Heath- Jarrow-Morton (HJM) model and the White-Hull model,
Black-Derman-Toy Interest Rate Model
It is mainly used for determining the value of derivatives by considering a preliminary zero rate term structure and the movement of the yield by constructing a tree explaining the interest rates. This model can also be a single-factor or multi-factor.
The Heath-Jarrow-Morton model
It uses statistical data and processes to derive the value of the derivatives by considering preliminary zero rate term structure and the up and down movement of future rates.
Hull-white model
It is a single factor that uses the preliminary term structure of interest rates with the up and down movement term structure to construct a trinomial free of short rates.
Equity pricing models
One of the widely used equity pricing model is the Capital Assets Pricing Model developed by William Sharpe and John Litner. It works on the premise that the return of a given security is affected by the risk called systematic. This risk is measured using beta () and it cannot be diversified away by holding a portfolio of securities. This model evolved from the portfolio theory which did not ...Show more
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Summary

With the advent of technology and computer, many models nowadays are calculated and evaluated using computer software which makes the whole process easy and faster. It is a fact that in a competitive world, companies should be able to make fast, timely and accurate investment decisions…
Financial modeling
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