Unified financial analysis: the missing links of finance.

Abstract

Financial analysis means different things to practitioners across a wide range of industries, disciplines, regulatory authorities and standard setting bodies. In daily practice, an accountant is likely to understand this term as bookkeeping and compliance with accounting standards. To a trader or a quantitative analyst, this term conjures up option pricing, whereas to a treasurer in a bank it can stand for liquidity gap analysis, measurement of market risks and stress testing scenarios. It could mean cost accounting and profitability analysis to a controller or a financial analyst valuing a company. A regulator or a compliance officer using this term has in mind primarily the calculation of regulatory capital charges. On the other hand, a risk officer in an insurance company is likely to think of simulating the one-year distribution of the net equity value using Monte Carlo methods. The examples mentioned above, and there are many others, make up a vast body of complex and specialized knowledge. It is only natural that practitioners tend to concentrate on a specific topic or subject matter, driven by the necessity of generating a report, an analysis or just a set of figures. The focus on the output drives the tools, systems, methodologies and, above all, the thinking of practitioners. Hedging the gamma risk of an option portfolio, for example, is after all quite different from managing short-term liquidity risk or backtesting a VaR model for regulatory purposes. This, however, is only superficially true. The mechanisms underlying these disparate analysis types are few, more common, and less complex than one would expect provided that everything is made as simple as possible but not simpler than that. The aim of this book is to expose these shared elements and show how they can be combined to produce the results needed for any type of financial analysis. Our focus lies on the analysis of financial analysis and not a specific analytical need. This also determines what this book is not about. While we discuss how market risk factors should be modeled, we cannot hope to scratch the surface of interest rate modeling. To use another example, the intricacies of IFRS accounting as such are not directly relevant to us, but the underlying mechanisms for calculating book values using these rules are.