Financial modeling: Using Excel in finance and economics

Financial modeling is the task of building mathematical models specific to a particular financial decision-making situation. The focus of the presentation is to use such models for finance and macroeconomic applications. More specifically, we use Microsoft Excel for the personal computer to apply mathematical, economic and financial principles and theories. The topics chosen for the presentation include portfolio theory and macroeconomic equilibrium models. In portfolio theory, we create a portfolio based on the Dow Jones 30 Industrials by collecting five years of monthly prices for each of the stocks that were collected. We use matrix algebra to determine the mean and standard deviation of the returns. We estimate the variance-covariance matrix using both the built-in covariance function in Microsoft Excel and matrix multiplication. We generate and plot the envelope curve. We estimate the Minimum Variance Portfolio. We estimate the Optimal Portfolio using both matrix multiplication and solver or maximization of the Sharpe ratio using the current value of the three month T-bill as a proxy for the risk-free rate. In macroeconomics, we use matrix algebra to solve systems of multiple equations with multiple unknowns. Financial modeling is a great tool for teaching. It enables students to perform financial analysis using computer models and apply financial principles in making corporate decisions, motivates the effective use of personal computers and selected software programs when solving business financial problems, and introduces students to the latest technology. The process of financial modeling helps them understand the impact that technological changes can have on financial analysis.