Financial Simulation Modeling in Excel, + Website

"I've worked with simulation in business for over 20 years, and Allman really nails it with this book. I admit that I own his previous book on structured finance cash flows, but I was surprised by what I found in here. He addresses the fundamental questions of how decision makers react to simulations and his read was very much in accordance with what I've experienced myself. When it came to the nuts and bolts of describing the different types of simulation analysis the book becomes incredibly detailed. There is working code and models for a fantastic array of the most common simulation problems. If you're so inclined, the book very carefully steps through the tricky math needed to really understand the theory behind stochastic modeling in finance. If you're preparing models that include any kind of randomization or stochastic modeling component, this book is a must-read, a tremendous value and time-saver." — David Brode of The Brode Group

A practical guide to understanding and implementing financial simulation modeling

As simulation techniques become more popular among the financial community and a variety of sub-industries, a thorough understanding of theory and implementation is critical for practitioners involved in portfolio management, risk management, pricing, and capital budgeting. Financial Simulation Modeling in Excel contains the information you need to make the most informed decisions possible in your professional endeavors.

Financial Simulation Modeling in Excel contains a practical, hands-on approach to learning complex financial simulation methodologies using Excel and VBA as a medium. Crafted in an easy to understand format, this book is suitable for anyone with a basic understanding of finance and Excel. Filled with in-depth insights and expert advice, each chapter takes you through the theory behind a simulation topic and the implementation of that same topic in Excel/VBA in a step-by-step manner.

• Organized in an easy-to-follow fashion, this guide effectively walks you through the process of creating and implementing risk models in Excel
• A companion website contains all the Excel models risk experts and quantitative analysts need to practice and confirm their results as they progress
• Keith Allman is the author of other successful modeling books, including Corporate Valuation Modeling and Modeling Structured Finance Cash Flows with Microsoft Excel

Created for those with some background in finance and experience in Excel, this reliable resource shows you how to effectively perform sound financial simulation modeling, even if you've yet to do extensive modeling up to this point in your professional or academic career.

Preface vii

Acknowledgments xi

About the Authors xiii

CHAPTER 1 Introduction 1

CHAPTER 2 Random Numbers, Distributions, and Basic Simulation Setup 13

CHAPTER 3 Correlation 47

CHAPTER 4 Option Pricing 65

CHAPTER 5 Corporate Default Simulation 95

CHAPTER 6 Simulating Pools of Assets 127

CHAPTER 7 Dealing with Data Deficiencies and Other Issues 153

CHAPTER 8 Advanced Topics and Further Reading 169

APPENDIX A Partial Differential Equations 175

APPENDIX B Newton-Raphson Method 183

References 187

Index 189

Keith A. Allman is an investment manager at Bamboo Finance, a private equity fund that invests in for-profit, commercially viable companies that provide a good or service that beneficially impacts the lives of low-income individuals. Previously, he was the director of analytics and modeling at Pearl Street Capital Group. Allman also founded Enstruct, which services clients worldwide in capital markets and equity valuation, distressed valuation, and quantitative-based training. He is the author of the Wiley titles Corporate Valuation Modeling, Modeling Structured Finance Cash Flows with Microsoft® Excel®, and Reverse Engineering Deals on Wall Street with Microsoft® Excel®. Allman holds bachelor degrees from UCLA and a master's degree from Columbia University.

Josh Laurito, CFA, is a co-founder and Principal of Lumesis, a leading provider of credit analysis software and solutions to the municipal finance market. In addition, he directs corporate modeling for Hexagon Securities, a boutique merchant bank that advises and invests in banks and specialty finance companies.

MichaelL Loh currently works for Tech-X Corporation where he is actively engaged in complex data management and high-performance computing using accelerated hardware. Prior to Tech-X, Loh developed and implemented financial models at RangeMark Financial Services

As simulation techniques become more prominent within the financial community, a thorough understanding of the theory behind, and implementation of, those techniques is critical for those involved in portfolio management, risk management, pricing, and other essential financial activities.

Created by the expert author team of Keith Allman, Josh Laurito, and Michael Loh, Financial Simulation Modeling in Excel contains valuable theoretical insights as well as practical exercises that will help you transform financial concepts into dynamic, usable models. And because simulation has its place in many different parts of finance, this well-rounded resource takes you step by step through the process of creating multiple, smaller models—using Microsoft® Excel® and VBA—as opposed to a single unified model.

Each section begins with a discussion of theory—with enough background and mathematical formulas provided to reinforce the concept covered—and then moves on to a Model Builder exercise where the theory is transferred to an application in Microsoft® Excel®. Along the way, this accessible guide:

• Works through random number generation, explains Brownian motion, and explores correlation between variables with specific examples

• Takes you through simulating interest rate paths to price bonds

• Creates a corporate default simulation based on structural and reduced form models

• Provides a thorough look at simulating pools of assets

• Addresses data deficiencies and how to manage data as it relates to a simulation

Complete with a companion website that contains information including Model Builder files, this book is an essential guide—for both seasoned professionals and those new to the world of financial simulation modeling—to understanding the intricacies of this discipline and excelling at it.