Book by Wayne Winston
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Models is the most in-depth book written about using @RISK, Evolver and
other DecisionTools software products to solve today's complex financial problems.
Author Wayne L. Winston is Professor of Decision and Information Sciences at Indiana
University and a leader in the field of Operations Research. The applications of
simulation and optimisation in the book (many of which have never been described
before in print) are new, novel approaches to options pricing, portfolio optimisation,
acquisitions modelling, VAR (value-at-risk) and more! This is truly a groundbreaking
book that should spur wide adoption of simulation and optimisation in finance.
Financial Models features years' worth of experience in setting up and solving complicated financial problems using Microsoft? Excel?and DecisionTools software. You will learn valuable analytical techniques that will help you get the most out of @RISK, Evolver, PrecisionTree?and TopRank? Each chapter covers one or more example problems (over 60 in all!), showing you step-by-step how to set up and analyse each model. This isn't a book of long-winded theoretical discussions. It's a practical, step-by-step guide that you can use immediately to build the models that you need!
The models in the book have been used at executive training classes at major corporations, including GM, NCR, PriceWaterhouseCoopers, and Bristol-Myers Squibb. All the models are included on CD-ROM along with trial versions of DecisionTools software. Dr. Wayne Winston is author of two of the leading MBA-level Operations Research texts, including Operations Research and Management Science. He is also author of Simulation Modeling Using @RISK, a popular hands-on guide to risk analysis and simulation with @RISK.
Wayne Winston's Decision Making Under Uncertainty with RISKOptimizer.
Winston's Financial Models Using Simulation and Optimization II.
If you build financial models, review them or just want to learn more about the applications of simulation and optimisation techniques to the financial aspects of your business, you need this book! 505 pp.
Inside Financial Models
Let's take a look at the types of problems you can solve with Financial Models Using Simulation and Optimization. Here are some excerpts:
Price Bundling. "Suppose you are a marketing manager for Microsoft and are trying to determine how to price Word and Excel. Families tend to value Word more than Excel while businesses tend to value Excel more than Word. Some groups may want to purchase both Word and Excel. How can we determine profit-maximising prices for this situation?" Pick your profit-maximising bundle prices using Financial Models and included software and models!
Simulating a New Product. "When a company develops a new product, the profitability of the product is highly uncertain. Simulation is an excellent tool to estimate the average profitability and riskiness of new products." Use Financial Models and included software and models to simulate the performance of your new products!
Simulating Development of a New Drug. "The pharmaceutical business deals with a very high degree of uncertainty. Over 90% of all products under development fail to come to market resulting in large losses. Products that do come to market (like Viagra and Prozac) can earn multi-billion dollar profits annually for 10-15 years (until their patent expires). @RISK is a natural tool to use in an effort to estimate whether a new product is worth developing." Use @RISK, Financial Models and included examples to simulate the performance of your highly uncertain ventures!
Using Simulation to Model An Acquisition. "Suppose we are considering purchasing a firm. The cash flows from the firm are highly uncertain. Future cash flows depend on many uncertain parameters such as Sales growth, Gross margin, SG and A expenses, Variations in Working Capital, Litigation Liability, and Terminal Value of firm. As the following example will show, simulation is well suited to modelling the uncertainty involved in a potential acquisition." Use @RISK, Financial Models and included examples to simulate your next acquisition!
Simulating Pro Forma Financial Statements. "A company's future profitability, borrowing, and many other quantities are all highly uncertain. It seems natural to run a simulation to obtain a range of values on future profitability and borrowing. We illustrate how to create a simulation of a Pro Forma financial statement (based on actual data) for Home Depot." Use @RISK, Financial Models and included examples to simulate financial statements in your line of work!
Pricing Exotic Options. "There are many exotic options, but they all share the property that the payoff from the option depends on the entire path of the stock price during the option's duration, not just the stock's price at expiration. To illustrate how Monte Carlo Simulation and the risk neutral approach can be used to price exotic options we show how to price a knockout put." Use @RISK, Financial Models and included examples to price all types of options!
Finding the Value at Risk (VAR) of a Portfolio. "Anybody who owns a portfolio of investments knows there is a great deal of uncertainty about the future worth of the portfolio. Recently the concept of value at risk (VAR) has been used to help describe a portfolio's uncertainty. Simply stated, value at risk of a portfolio at a future point in time is usually considered to be the fifth percentile of the loss in the portfolio's value at that point in time. In short, there is considered to be only one chance in 20 that the portfolio's loss will exceed the VAR. The following example shows how @RISK can be used to measure VAR. The example also demonstrates how buying puts can greatly reduce the risk, or hedge, a long position in a stock." Use @RISK, Financial Models and included examples to calculate your VAR!
Computing VAR for Forwards and Futures. "Many corporations face the risk that their profit will greatly change when commodity prices or currency rates change. For example, a glass making company uses natural gas to heat their furnaces. They face the risk that the price of gas will increase, thereby increasing their costs. A drug company selling drugs in Germany faces the risk that a decline in the value of the mark will reduce the value of their German accounts receivable. Futures and forwards can be used to hedge commodity and exchange risk." Use @RISK, Financial Models and included examples to hedge commodity and exchange risk!
Hedging with Futures. "How many futures do you need to buy to adequately hedge your risk? In this chapter we show how to use @RISK to determine optimal hedging policies. Our goal will be to choose a hedging policy that minimises the standard deviation of our total costs." Use @RISK, Financial Models and included examples to develop your hedging policy!
Delta Hedging. "A financial institution that sells options is at great risk. For example, if a Wall Street firm sells a call option there is no theoretical upper limit on the discounted cash value that the purchaser of the option will receive at expiration. Delta hedging enables a firm writing options to control the riskiness of their position." Use @RISK, Financial Models and included examples to explore Delta hedging!
Using the Risk-Neutral Approach to Value Real Options. "The risk-neutral approach enables us to value many quantities which derive their value from an underlying asset. In most books, you do this by finding a combination of puts and calls which replicates the payoffs of what you are trying to value. We do not need to do this. Just use the lognormal to simulate the future value of the underlying asset (growing at risk-free rate)." Use @RISK, Financial Models and included examples to value real options!
A "Pioneer Option. "Often companies enter into small projects that have a negative NPV. The reason for this is that participation in the smaller project gives the company the option to later participate in a larger project that may have a large positive NPV. Merck Pharmaceuticals, led by their CFO Judy Lewent has "pioneered" the use of real option theory." Use @RISK, Financial Models and included examples to value Pioneer options!
Pricing American Options with Binomial Trees. "American options are usually priced with binomial trees. We divide the duration of the option into smaller time periods (usually weeks or months). During each time period the stock price either increases by a factor u or decreases by a factor d." Use Financial Models and the included examples to value American options with binomial trees!
Valuing the Option to Purchase a Company. "The binomial tree approach to valuing an option is very flexible. It can be used to value many "real investment options" such as an option to purchase, and option to contract operations and an option to expand." Use @RISK, Financial Models and included examples to use binomial trees to value your investment options!
Real World Issues
Wayne Winston applies his tools and expertise to real-world problems common in the business world. Here are just a few of these:
|Problems Reviewed||Techniques Demonstrated|
|analysing acquisitions||fitting an S-shaped curve|
|portfolio optimisation||portfolio approach to project selection|
|simulating a yield curve||price bundling|
|funding pension liabilities||simulating profitability for a new product|
|finding VAR for a portfolio||generating implied forward rates|
|evaluating pro forma financial statements||immunisation against interest rate risk|
|valuing real options||valuing an option to purchase a company|
|...And more!||...And more!|
Read about Financial
Models Using Simulation and Optimization II.
Read about Decision Making Under Uncertainty with RISKOptimizer.
Go to the Risk Analysis Books page.
Read more about RISKOptimizer.