Monte Carlo simulation as a risk management tool. It employs computational algorithms that require random sampling to generate solutions to complex problems. Monte Carlo simulation software saves researchers the time and effort of originating algorithms for their specific project. Monte Carlo stress testing attempts to put a finite limit on the number of algorithms that apply in a particular case.

Companies like Oracle, Palisades and Lumenaut have customized a Monte Carlo simulation for Excel. The diverse applications and uses for software supported on "Monte Carlo simulation excel" include financial risk analysis, valuation, engineering, portfolio allocation, cost estimation, and project management.

1. Study Monte Carlo Simulation as a risk management tool. Applications and uses should be examined in the process. Perhaps use a free Monte Carlo simulation to judge its value to you.

2. Test a free Monte Carlo simulator to make sure your problem is complex enough to benefit from a risk management Monte Carlo simulation.

3. Work with Monte Carlo simulation stress testing to make sure even a complex Monte Carlo simulation can withstand the complexity of your problem.

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Learn about Monte Carlo simulation as a management tool

Monte Carlo simulations are highly complex and were developed by the same scientists who worked on the Manhattan Project in New Mexico during World War 2. To effectively use something you must understand it. This will help you determine how to apply a Monte Carlo simulation download to meet your needs.

I recommend: Visit some websites that define and explain Monte Carlo simulations. Solver.com has an outstanding primer on what a Monte Carlo simulation is and how it can be used in different situations. For more advanced users, The University of Nebraska offers a more detailed explanation that includes sample algorithms.

Evaluate Monte Carlo simulation software applications

Once you understand how a Monte Carlo simulation can solve a problem you will then be faced with evaluating and selecting different Excel spreadsheet-based Monte Carlo simulation software tools. Several companies have developed such tools and offer commercial applications.

I recommend: Oracle has a well-deserved reputation for developing elegant software solutions to complex business problems. The Oracle Crystal Ball solution is technically sound and versatile. A smaller company, Lumenaut, specializes in Monte Carlo simulation software for Excel and has the advantage of 15-day free trial simulator downloads.

Specify how Monte Carlo simulation software could meet your needs

Now that you understand how Monte Carlo simulations work and have explored some general commercial solutions, it's time to get specific regarding how these tools can apply to your needs. Financial risk management is a common application for Monte Carlo simulations in the business world, while appraising financial value is highly practical.

I recommend: Evaluate the specifics of your situation and determine how or if a Monte Carlo simulation will deliver an adequate risk/reward valuation. If your interest is financial risk management you can look at how a Monte Carlo simulation evaluated Global Derivatives and apply that analysis to your needs. If your interest is more mercenary, look at the Social Science Research Network to help put a dollar value on a Monte Carlo simulation application.

Tips & Tactics

Helpful advice for making the most of this Guide

• •  Nothing related to Monte Carlo simulation software uses or applications is simple or intuitive. Unless you have a graduate school-level background in mathematics you might consider hiring a consultant to help you wade through and analyze how these tools can work for you.

Monte Carlo simulation as a risk management tool helps project managers to develop contingencies plans on major projects. Since certain circumstances are out of the project manager's control, such as, delivery or manufacturing delays, it's a good idea to have back-up plans in case these situations occur in order to avoid a delay in the completion of the entire project. Developing these contingency plans involves quantifying the risk of adverse situations and delays.

Quantifying risk involves algorithms, probability and statistics, all of which are not simple calculations. Avoid the timely effort it takes to make these calculations by hand by purchasing Monte Carlo simulation software. Here are the basics of what various types Monte Carlo simulation software provides.

1. Monte Carlo stress testing provides possible outcomes to adverse conditions such as manufacturing and delivery delays.

2. Monte Carlo risk management software allows the project manager to assess both global and local risks.

3. Monte Carlo simulation software allows the project manager to calculate differing scenarios of the project's outcome. The three basic scenarios of any project are the best case, worst case and probable outcomes. Inputting variables into simulation software calculates all three scenarios.

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Try out free Monte Carlo simulation software before purchasing the full program

Free Monte Carlo simulation software allows you to try out different programs to see which one best suits your company's needs.

I recommend: Download a free Monte Carlo simulator from Source Forge, Inc. Get a Monte Carlo simulation download from Softpedia.

Buy the add ins when you purchase Monte Carlo simulation software for Excel

The Monte Carlo simulation Excel and other simulation programs allow for more extensive changes in the inputs and then reports them in a new summary sheet and histogram.

I recommend: Get the Monte Carlo simulation for Excel add ins at Cambridge University Press and Ozgrid.

Buy comprehensive risk management software that includes Monte Carlo risk management tools as well

Comprehensive risk management programs allow the project manager to compare the results from Monte Carlo stress testing and other risk management simulations to help develop the best contingency plans for a given project.

I recommend: Real Options Valuation, Inc. and GoldSim Technology Group offer Monte Carlo simulation software combined with other risk management techniques.

Tips & Tactics

Helpful advice for making the most of this Guide

• •  Always remember to consider current market conditions when using Monte Carlo Simulation as a risk management tool. Market conditions may change rapidly, at any given time, the Monte Carlo simulation doesn't take the changing market conditions into consideration when computing its summary. Take this important fact into consideration when developing a contingency plan for a project.

Monte Carlo risk management methods are computational algorithms using repeated random samplings to draw conclusions regarding complex problems. The randomness and complexity mean that Monte Carlo stress testing is best done using a computer program like Monte Carlo simulation for Excel. It is sometimes possible to get a free Monte Carlo simulator or free Monte Carlo simulation software.

Monte Carlo simulation as a risk management tool education and training is helpful in judging probabilities in fields like business management, financial management, science and mathematics. Business applications are often augmented by Monte Carlo simulation as a risk management tool education and training. A good business strategy is go look for a free Monte Carlo simulation in risk management.

1. Learn how Monte Carlo simulation as a risk management tool education and training can solve your business problems.

2. Research the various flavors of Monte Carlo simulation in Excel and other software programs and find one that applies to your business.

3. Explore the affects of Monte Carlo simulations with a Monte Carlo simulation download.

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Learn how a Monte Carlo simulation works

Explore the basics of Monte Carlo simulation on the Internet and in literature specific to your needs. In its most simple form, Monte Carlo simulations define a domain of possible inputs, generate random inputs from that domain, use those inputs to determine one or several computations, and aggregate those results into a final, useful result.

I recommend: The Computational Science Education Project offers an online version of its primer on Monte Carlo Simulations which includes a case study. The Sitmo Quant Equation Archive gives sample computations, including those for business applications. Learning this basic information will help you evaluate business solutions such as free Monte Carlo simulation software.

Explore options in Monte Carlo simulation software and Monte Carlo simulation in Excel

Now that you understand the basics, it is time to get more specific with your software options. Surf the Internet to discover what your options are and discover those that meet your needs.

I recommend: Stanford University offers detailed reviews of Monte Carlo simulation software in Excel. Some of these software solutions come with free samples. Analycorp offers another academic treatment of Monte Carlo risk management education and training. A trial XL version is available free.

Review some commercial applications of Monte Carlo simulation as a risk management tool

Leading software companies offer Excel-based software to support Monte Carlo simulations, in part as an education and training tool. Samples or introductory versions are often free.

I recommend: Oracle's Crystal Ball product has a low-cost version for students and educators that performs Monte Carlo simulations at a reduced cost. This might be a worthwhile solution for academics. Lumenaut offers Monte Carlo simulation software in Excel. This product comes with a 15-day free trial for education, training and demonstration purposes.

Tips & Tactics

Helpful advice for making the most of this Guide

• •  There is nothing intuitive or simple about Monte Carlo Simulation software. Unless you have an advanced degree in mathematics or computer science, you might want to consider hiring a consultant well versed in Monte Carlo simulation as a risk management tool for education and training.

Atom-bomb scientists coined the term Monte Carlo method after Europe’s casino capital in Monaco to highlight the "random chance" aspect of the model. Monte Carlo simulations perform multiple calculations using random variables to determine the probably outcome of a given situation. Today specialists employ the technique in fields as diverse as weather prediction, oil exploration, sales forecasts and financial planning. Before using Monte Carol simulation models or working with a consultant to manage risk, get familiar with some key terms to understand Monte Carlo basics.

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Stochastic

Mathematicians refer to Monte Carlo simulations as stochastic, meaning they involve conjecture or randomness. This refers to the way a simulation model generates random numbers to pose possible outcomes, as well as calculate the likelihood of these outcomes occurring. At the opposite end, with 'deterministic' you're in control by calculating one set of 'if/then' answers for each 'what if' question you pose on a set of parameters.

I recommend: TreeAge Software discusses the use of parameters both in pre-set, deliberate (or deterministic) analysis as well as random (or stochastic) analysis.

Parameters

Parameters are the boundaries you place on the model--what factors will affect the outcome that you're trying to test, and for each factor, what is its range is from absolute minimum to absolute maximum. When you set these parameters, the Monte Carlo system selects random numbers within those defined ranges to run through the algorithm to calculate the final solution set.

I recommend: Beige Bag Software demonstrates how you use parameters to set up or change the Monte Carlo simulation model.

Algorithm

If you've seen a flowchart, you've looked at an algorithm that's been graphed out. It's the frequently complex mathematical instructions a Monte Carol simulation package uses to generate the random numbers and perform the calculations necessary to create the model.

I recommend: The bottom of the Michigan State University web page delineates the components comprising a typical Monte Carlo algorithm.

Sensitivity

All things aren't equal in the real world; some aspects of a business scenario carry more weight on the circumstances you're evaluating. The outcome you want to model can be extremely sensitive to certain aspects, immune to others. The Monte Carlo simulation correlates the individual parameters' measured impact to the forecasted outcome, providing you with a chart showing how much impact any given parameter has on the overall outcome.

I recommend: Investopedia explains sensitivity analysis in financial analysis, such as stocks and bonds. Pharmalicensing shows the output of a Monte Carlo simulation, including a sensitivity chart.

Worst case

Monte Carlo simulations, based on calculations from random numbers, helps you build a model of uncertainty to better understand business situations. Rather than hoping for the best and fearing the worst outcomes, ask 'what if' with the Monte Carlo simulation to determine best-case and worst-case outcomes, plus what probability the best-case or worst-case scenario will occur.

I recommend: Frontline Systems' Solver.com posts a step-through of Monte Carlo simulations, describing how they model worst-case scenarios. The Materials Research Society posts an abstract discussing the use of Monte Carlo modeling on the Yucca Mountain nuclear waste repository to determine worst-case scenarios for the barriers’ lifespan.

Stress test

If you want to know how your business will fare under adverse conditions, use a Monte Carlo simulation to create a stress test. The test will create a baseline for you to better assess overall risk by answering 'how bad can it get?'

I recommend: Palisade Corporation talks about how the Federal Reserve tested the nation’s banking system after the housing market meltdown.