Sensitive Analysis and Scenario Analysis



What is Sensitivity Analysis? Sensitivity Analysis is a technique used in financial modelling to examine the impact of various values of a group of independent variables on a certain dependent variable, given precise circumstances. Sensitivity analysis is often used across several disciplines, including biology, geography, economics, and engineering. It is particularly valuable in the examination and evaluation of a "Black Box Process" when the result is an obscure function of several inputs. An opaque function or process is one that cannot be comprehensively examined or analysed due to certain limitations or restrictions. Climate models in geography, for instance, tend to be quite intricate. Consequently, the precise correlation between the inputs and outcomes is not well understood.

What- If Analysis A Financial Sensitivity Analysis, sometimes referred to as a What-If analysis or a What-If simulation exercise, is primarily used by financial analysts to forecast the result of a certain action when executed under specified circumstances. Financial Sensitivity Analysis is conducted within predetermined limits, which are established by the set of independent (input) variables. For instance, sensitivity analysis may be used to examine the impact of a 1% rise in interest rates on bond prices. The "What-If" inquiry would be: "What would be the impact on the price of a bond if interest rates were to increase by 1%?" Sensitivity analysis may provide a solution to this challenge.

Scenario Analysis Sensitivity analysis and scenario analysis are two distinct methods used in financial analysis. It is crucial to avoid conflating Financial Sensitivity Analysis with Financial Scenario Analysis. While sharing some similarities, the two entities possess distinct variations. Sensitivity Analysis is used to ascertain the impact of a group of independent factors on a dependent variable under certain circumstances. For instance, a financial analyst seeks to determine the impact of a company's net working capital on its profit margin. The study will include all the factors that have influence on the company's profit margin, including the cost of items sold, workers' pay, managers' compensation, and so forth. The study will identify and separate each of these predetermined and fluctuating expenses and document all the potential results. Scenario Analysis, conversely, requires the financial analyst to meticulously scrutinise a certain scenario. Scenario Analysis is often used to examine circumstances characterised by significant economic disruptions, such as a worldwide market upheaval or a substantial change in the nature of the industry. Once the facts of the scenario are specified, the analyst must next identify and define all the pertinent variables to ensure they are consistent with the scenario. The outcome is an exceedingly thorough depiction of the future (a distinct scenario). The analyst has comprehensive knowledge of all potential outcomes, even extreme possibilities, and can accurately predict the precise results based on a predetermined set of factors inside a real-life situation.

Benefits of Financial Sensitivity Analysis Conducting sensitivity analysis is crucial for many significant reasons: Sensitivity analysis enhances the reliability of financial models by subjecting them to extensive testing across a range of scenarios. Financial Sensitivity Analysis enables the analyst to adjust the parameters within which the sensitivity of the dependent variables to the independent variables may be tested. For instance, the model used to analyse the impact of a 5-point alteration in interest rates on bond prices would vary from the financial model utilised to examine the consequences of a 20-point variation in interest rates on bond prices. Sensitivity analysis facilitates the process of making well-informed decisions. The model is used by decision-makers to comprehend the degree of responsiveness of the output to alterations in certain factors. Therefore, the analyst may assist in drawing concrete findings and play a crucial role in making optimum selections.

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