18-06-2013, 02:39 PM
Financial Modelling Using Excel
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Q.1 What do you mean by Modelling & Financial Modelling?
A "model" is the representation of some abstraction from some "part of reality". A model can exist in a person’s head only, invisible to everyone else, or it can also exist external to the modeller, for example as a diagram on paper, or a piece of text or mathematics.
The standard map of the London Underground is a model.
It represents a certain abstraction from the real underground system.
Things included in the abstraction:
Lines (Piccadilly, Victoria, etc.),
Connections (Where you can change from the Northern Line to the Central Line, etc.),
The order of stations on each line.
Things left out of the abstraction:
The distances between stations,
The orientation of stations at ground level,
The depth of the underground tunnels.
The kind of model which a person requires of a system depends upon the relationship between the person and the system. For instance, the user of a gas cooker is interested in how to cook food: turn the gas rings and oven on and off, set the oven timer, and so on; the service engineer is interested in how to fix the cooker when it goes wrong; the manufacturer is interested in how to put it together; whilst the delivery van driver is only interested in how best to get it on and off the van! Each of these people will require a different model of the system, even though several of these models may have aspects in common.
Stages of modelling
It is helpful to divide up the process of modelling into four broad categories of activity, namely building,studying, testing and use. Although it might be nice to think that modelling projects progress smoothly from building through to use, this is hardly ever the case. In general, defects found at the studying and testing stages are corrected by returning to the building stage. Note that if any changes are made to the model, then the studying and testing stages must be repeated.
A representation of potential routes through the stages of modelling is:
1. Studying
2. Testing
3. Use
4. Building
This process of repeated iteration is typical of modelling projects, and is one of the most useful aspectsof modelling in terms of improving our understanding about how the system works.
Financial Modelling
Financial modeling is the task of building an abstract representation (a model) of a financial decision-making situation. This is a mathematical model designed to represent (a simplified version of) the performance of a financial asset or portfolio of a business, project, or any other investment. Financial modeling is a general term that means different things to different users; the reference usually relates either to accounting and corporate finance applications, or to quantitative finance applications. While there has been some debate in the industry as to the nature of financial modeling - whether it is a tradecraft, such as welding, or a science - the task of financial modeling has been gaining acceptance and rigor over the years. Typically, financial modelling is understood to mean an exercise in either asset pricing or corporate finance, of a quantitative nature. In other words, financial modelling is about translating a set of hypotheses about the behavior of markets or agents into numerical predictions; for example, a firm's decisions about investments (the firm will invest 20% of assets), or investment returns (returns on "stock A" will, on average, be 10% higher than the market's returns).