Financial Modeling

Getting Started

What is Modeling?
Blueprint Model

What is Modeling?
If Carle had modeled its new parking garage it might have seen that the elevator from the Medivac Helipad on the roof to the Emergency Room on the ground floor was not big enough to accommodate a gurney.

What is Financial Modeling?

A financial model illustrates relationships using real (realistic) numbers so that it can answer what if? questions or make projections.
Financial Theory Accounting & Financial Relationships

Financial Model

Model
A Model specifies the relationship between inputs and outputs.

Output

r FV P 1 n

n*t

Inputs

Deterministic Model
A Deterministic Model generates the same output every time you calculate

r 9 8% FV P 1 $241,171.4 0 $219,112.3 1 $100,000 1 n 2

n*t

2*10

What happens to the Future Value if the interest rate increases?

Stochastic Model
A Stochastic Model uses random inputs and gets a different output every time you calculate. r~N(3%,2%)

r FV P 1 n

n*t

Now what happens to Future Value?

Attributes of Good Models

Realistic Error-Free Flexible Easy to use Easy to understand

Attributes of Good Models

Realistic
Assumptions, relationships, and inputs must be realistic so that the outputs are useable. Example: The S&P model that assigned AAA ratings to sub-prime mortgage derivatives
constrained the price change in houses to be positive. had no demographic parameter

Attributes of Good Models

Error Free
harder than it looks

Attributes of Good Models

Flexible
This is a two edged sword. Develop the model to be easy and error free, then add elements of flexibility. Experience will tell you when a model gets too complicated and should be segregated into separate models for separate purposes.

Attributes of Good Models

Easy to use
Use clear labels and descriptions
Calendar Year 2007 2008 2009 2010 $ $ $ $

Planned saving in calendar year:

vs

t
2007 2008 2009 2010 $ $ $ $

St

Attributes of Good Models

A financial model is only as good as the analyst using it.
The Harvard Interest Rate Model

Course
This course was created in response to feedback from corporate recruiters.
Stays with you

Training Education

Stays with the corporation

Course Structure

Course Structure
Models Quizzes Projects

Models:
In each class we will develop a model or portion thereof Each model will be given a due date (generally noon on the day following the class)

Models
Models returned with comments
You are encouraged to resubmit corrected models for 80% of full marks. The due date for re-submissions is noon on the day following the next class. There are no re-re-submissions

Note:
We will frequently work a model from class to class. If you do not have the previous model completed then you will have nothing with which to work If you miss a class remember that the template and class powerpoint in on Compass.

Submit models through the course web page:

Submission
http://www.business.uiuc.edu/ finance/FinancialModeling/ Submissions are automatically time and date stamped and off loaded when due.

Quizzes:
There are several in-class Quizzes throughout the course These are due at the end of the class period. Quizzes are designed to test your modeling skills under pressure; there are no re-submissions.

Projects:
Presentation of a model developed
As an extension of a class model For another class (so long as you have permission from the instructor) For an internship or other work (so long as you have permission from the company for whom the model was developed)

Presentations are peer evaluated.

Professionalism
Professionalism requires collaboration, not cheating.
You are encouraged to help each other succeed, but not by doing their work for them. I expect each student to develop their models independently. Copying anothers model is considered cheating and will result in a grade of 0.

Professionalism
Professionalism requires decorum
While in class you will work on Financial Modeling. Students working on games, email, networking, or assignments for other classes will be asked to work elsewhere.

Financial Modeling
Some notes before we begin

Finance vs Modeling
The assumption is that you know the finance If you need to refresh your memory
Financial Markets (Oltheten & Waspi) Corporate Finance Financial Modeling (Sengupta)

Excel Issues

Its not a bug, its a feature

Mathematics
Excel uses the IEEE* Double Precision Floating Point number format (15 decimal places Thus 1/3 + 1/3 + 1/3 = 0.999999999999999 If you want 1/3 + 1/3 + 1/3 = 1 you are now out of balance.
*Institute of Electrical and Electronic Engineers

Data vs Format
Data can be formatted to look like anything
5% is stored as 0.05 1 September 2008 is stored as the number 39,692 and can be used in further calculation. September 1, 2008 is stored as September 1, 2008 and must be manipulated as text.

Excel Versions
Excel 2007 is not an upgrade of Excel; it differs substantially from earlier versions BIF Trading Lab
Excel 2007 is the default Excel 2003 must be started and then filled with a file

Excel 2007
Buries functionality behind "user friendly" graphics 65535 is rendered as 100,000 VBA is inconsistent with previous versions.

Excel 2007
Saves files as *.xlsx, *xltx, or *xlsb all of which are incompatible with previous versions of excel.
Use Save as and save as *.xls before submitting

Excel 2007
Interview topic
Ask which version the company uses

Multiplication Tables
Exercise 1

Using Excel
Formatting Your Workspace

Toolbars
Customize your toolbars
Whenever you find yourself using the same command again and again
Add the command to your toolbar Learn the shortcut

Fin490.xla

Save all worksheets with the focus on cell A1

*.xla is an excel add-in Download fin490.xls from Compass

Fin 490 Format Menu

Fin490.xla
On your own Computer *.xla is saved as *xla and placed in the xlstart subdirectory of your computer C:\Program Files
Microsoft Office
Office 11 Xlstart Fin490.xla

Fin490.xla
In the classroom/lab
*.xla can be parked on your flash drive and opened whenever you work

Customizing Fin490.xla
Open Fin490.xls [Alt][F11] to open VBA Click on Modules/Headings
Interior color is light orange
' Keyboard Shortcut: Ctrl+Shift+T ' Selection.Font.Bold = True Selection.Font.ColorIndex = 55 With Selection.Interior .ColorIndex = 45 .Pattern = xlSolid End With

Font color is Indigo

Customizing Fin490.xla
In Fin490.xls
Pick your colors and edit the VBA Test by using Ctrl+Shift+T Format/ Sheet/ Hide Add Modified by --- and date Save as Fin490.xla

*.xla is an addIn

Fin490.xla
Fin490.xla is an add In
When you open Fin490.xls you have a spreadsheet that does stuff When you open Fin490.xla you have an add in that does the same stuff but you see no spreadsheets

Financial Modeling
Getting Started