What is a financial model?
It is a mathematical model showing the likely financial outcomes of any asset, whether a portfolio of shares or the performance of an individual business. Typically, they will examine different economic scenarios for the future or valuations of individual assets, whether individual securities, a portfolio or a business.
Where have you heard about financial models?
As an investor, one or more of the companies in which you are invested may refer to financial modelling as part of its forward planning. Similarly, literature issued by asset managers may assure investors that rigorous financial modelling is employed when scrutinising potential investments.
What you need to know about financial models.
There is a range of applications for financial models. These include risk modelling, portfolio optimisation and investment management. One of the best-known is the Capital Asset Pricing Model, which calculates the appropriate rate of return on an asset given the level of risk involved.
Financial models seek to incorporate all possible variables to make their forecasts robust but they can stay vulnerable to an unpredictable and devastating happening, what is known as a 'black swan event', an expression that denotes both its rarity and potential implications.
Find out more about financial models.
Financial modelling forms part of financial forecasting. Read about financial forecasting here.