financial modeling

Examples of financial modeling in the following topics:

• Strategic Planning

  • Financial forecasting is often helped by processes of financial modeling.
  • 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.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 or investment returns.

• Financial Applications of Quadratic Functions

  • The method of graphing a function to determine general properties can be used to solve financial problems.Given the algebraic equation for a quadratic function, one can calculate any point on the function, including critical values like minimum/maximum and x- and y-intercepts.
  • Suppose this models a profit function $f(x)$ in dollars that a company earns as a function of $x$ number of products of a given type that are sold, and is valid for values of $x$ greater than or equal to $0$ and less than or equal to $500$.
  • If a financier wanted to find the number of sales required to break even, the maximum possible loss (and the number of sales required for this loss), and the maximum profit (and the number of sales required for this profit), they could simply reference a graph instead of calculating it out algebraically.

• Leverage Models

  • Models that allow us to interpret appropriate financial leverage include the Modigliani-Miller theorem and the Degree of Financial Leverage.
  • There are several measures we can use to define and quantify the effect of financial leverage.
  • Financial leverage can be measured, or defined, using certain ratios.
  • The higher the Degree of Financial Leverage, the riskier the business.
  • Financial leverage is defined as the ratio of operating income to net income.

• Creating a Budget

  • Construct a model of how a business might perform financially if certain strategies, events, and plans are carried out
  • One approach is based on mathematical models, and the other on people.
  • The first school of thought believes that financial models, if properly constructed, can be used to predict the future.
  • Investments of time and money are devoted to perfecting these models, which are typically held in some type of financial spreadsheet application.
  • The other school of thought holds that it's not about models, it's about people.

• Managerial Accounting

  • When looking at traditional financial accounting, managerial accounting differs in a few key ways:
  • Financial accounting is generally historical, while managerial accounting is about forecasting.
  • Managerial accounting tends to lean a bit more on abstraction, utilizing various models to support financial decisions.
  • While financial accounting fits the mold expected by stakeholders, managerial accounting is flexible and strives to meet the needs of management exclusively.
  • Financial accounting looks at the company holistically, while financial accounting can zoom in at various levels (i.e. product level, division level, etc.)

• Behavior of an Efficient Market

  • Efficient-market hypothesis (EMH) asserts that financial markets are informationally efficient and should therefore move unpredictably.
  • Critics have blamed the belief in rational markets for much of the late-2000's financial crisis.
  • Historically, there was a very close link between EMH and the random-walk model and then the Martingale model.
  • A small number of studies indicated that U.S. stock prices and related financial series followed a random walk model.
  • The paper extended and refined the theory, included the definitions for three forms of financial market efficiency: weak, semi-strong, and strong.

• The Financial Value of Social Responsibility

  • CSR provides a financial return in the form of lower costs, higher revenue, and returns to investors.
  • Evidence links socially responsible business practices to improved financial performance.
  • In this way, the shared value model takes a long-term perspective on the financial benefits of corporate social responsibility.
  • Other financial benefits from CSR accrue directly to shareholders.
  • Similarly, academic studies have shown that excluding stocks from companies with poor CSR records does not adversely effect financial returns of a fund.

• Finding an Equilibrium Exchange Rate

  • In other words, money is not only chasing goods and services, but to a larger extent, financial assets such as stocks and bonds.
  • The flows from transactions involving financial assets go into the capital account item of the balance of payments, thus balancing the deficit in the current account.
  • The increase in capital flows has given rise to the asset market model.
  • The asset market model views currencies as an important element in finding the equilibrium exchange rate.
  • The key difference between the balance of payments and asset market models is that the former includes financial assets, such as stock, in its calculation.

• Basic Components of Asset Valuation

  • Items that are usually valued are a financial asset or liability.
  • Valuation of financial assets is done using one or more of these types of models:
  • These kinds of models take two general forms: multi-period models such as discounted cash flow models or single-period models such as the Gordon model.
  • Option pricing models are used for certain types of financial assets (e.g., warrants, put/call options, employee stock options, investments with embedded options such as a callable bond) and are a complex present value model.
  • The most common option pricing models are the Black–Scholes-Merton models and lattice models.

• Maximizing Shareholder and Market Value

  • Financial management is concerned with financial matters for the practical significance of the numbers, asking: what do the figures mean?
  • There are several goals of financial management, one of which is maximizing shareholder and market value .
  • There are many different models of corporate governance around the world.
  • The Anglo-American (US and UK) "model" tends to emphasize the interests of shareholders.
  • Maximizing shareholder and market value is, for some, one of the goals of financial management.