Cash-Flows – Certainty and Uncertainty: Financial Modeling Training

by on September 12, 2012 in Course Preparation, Financial Management, Financial Modeling Using MS Excel

Cash-Flows – Certainty and Uncertainty: Financial Modeling Training

Cash-Flows is one of the most essential topics in finance and a must study for Financial Modeling training. Cash-flows generally come with uncertainty and involve risks. However, there are situations when it is not the same. Thus there can be two faces of cash-flows – Certainty and Uncertainty in this post. Based on these two faces, cash-flows can be classified into Deterministic and Stochastic. Let’s discuss about the same in this post.
Deterministic Cash-Flows
When there is no uncertainty related to the future value or timing of a cash-flow, one says that the cash-flows is “Deterministic”. This means the cash-flow does not have any risk attached to it. Examples of deterministic cash-flows are stated as below.
Examples of Deterministic Cash-Flows

  • Government bonds can be assumed to have no risk of default
  • Coupons on fixed-income instruments with risk of default
  • Any cash-flows those are post-determined such as future cash-flows based on some market interest-rates that are known at the time of projections and so on.

Stochastic Cash-Flows
Stochastic is completely opposite to deterministic. A “Stochastic” cash-flow is a cash-flow that holds some sort of uncertainty. The uncertainty can relate to any aspect relevant to the cash-flow: value, time or anything else that could be relevant. The term stochastic comes from “stochastic process” which is a collection of random variables through time. Each random variable corresponds to the value of a phenomenon observed at a specific point in time. A random variable is a variable that can take different values; each value being given a specific probability.
Types of Random Variables:

  • Discrete Random Variables: Some random variables are called discrete when there are finite numbers of values.
  • Continuous Random Variables: Some other random variables on the other hand are called continuous because they take their value within some continuum.

Examples of Stochastic Cash-Flows:

  • Corporate bonds with risk of default
  • Dividend for stocks quoted on a Stock exchange
  • Coupons from variable-rate securities
  • Cash-flows from Mortgage-backed securities and so on.

These are the most important basics of cash-flows. To know more about cash-flow, you can explore our training courses on Financial Modeling. Simplilearn offers both online and classroom training on Financial Modeling.

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