Palisade RISK 4.5 User Manual

Guide to Using

@RISK

Risk Analysis and Simulation

®

Add-In for Microsoft

Version 4.5

June, 2005

Excel

Palisade Corporation
798 Cascadilla St.
Ithaca, NY USA 14850
[phone]
[phone] (fax)
http://www.palisade.com (website)
[e-mail] (e-mail)

Copyright Notice

Copyright © 2005, Palisade Corporation.

Trademark Acknowledgments

Microsoft, Excel and Windows are registered trademarks of Microsoft, Inc.
IBM is a registered trademark of International Business Machines, Inc.
Palisade, TopRank, BestFit and RISKview are registered trademarks of Palisade
Corporation.
RISK is a trademark of Parker Brothers, Division of Tonka Corporation and is used under
license.

Welcome

@RISK for Microsoft Excel

Welcome to @RISK, the revolutionary software system for the
analysis of business and technical situations impacted by risk! The
techniques of Risk Analysis have long been recognized as powerful
tools to help decision-makers successfully manage situations subject
to uncertainty. Their use has been limited because they have been
expensive, cumbersome to use, and have substantial computational
requirements. However, the growing use of computers in business
and science has offered the promise that these techniques can be
commonly available to all decision-makers.

That promise has been finally realized with @RISK (pronounced "at
risk") — a system which brings these techniques to the industry
standard spreadsheet package, Microsoft Excel. With @RISK and
Excel any risky situation can be modeled, from business to science
and engineering. You are the best judge of what your analysis needs
require, and @RISK, combined with the modeling capabilities of
Excel, allows you to design a model which best satisfies those needs.
Anytime you face a decision or analysis under uncertainty, you can
use @RISK to improve your picture of what the future could hold.

Why You Need Risk Analysis and @RISK

Traditionally, analyses combine single "point" estimates of a model's
variables to predict a single result. This is the standard Excel model
— a spreadsheet with a single estimate of results. Estimates of model
variables must be used because the values which actually will occur
are not known with certainty. In reality, however, many things just
don't turn out the way that you have planned. Maybe you were too
conservative with some estimates and too optimistic with others. The
combined errors in each estimate often lead to a real-life result that is
significantly different from the estimated result. The decision you
made based on your "expected" result might be the wrong decision,
and a decision you never would have made if you had a more
complete picture of all possible outcomes. Business decisions,
technical decisions, scientific decisions ... all use estimates and
assumptions. With @RISK, you can explicitly include the uncertainty
present in your estimates to generate results that show all possible
outcomes.

Welcome i

@RISK uses a technique called "simulation" to combine all the
uncertainties you identify in your modeling situation. You no longer
are forced to reduce what you know about a variable to a single
number. Instead, you include all you know about the variable,
including its full range of possible values and some measure of
likelihood of occurrence for each possible value. @RISK uses all this
information, along with your Excel model, to analyze every possible
outcome. It's just as if you ran hundreds or thousands of "what-if"
scenarios all at once! In effect, @RISK lets you see the full range of
what could happen in your situation. It's as if you could "live"
through your situation over and over again, each time under a
different set of conditions, with a different set of results occurring.

All this added information sounds like it might complicate your
decisions, but in fact, one of simulation's greatest strengths is its
power of communication. @RISK gives you results that graphically
illustrate the risks you face. This graphical presentation is easily
understood by you, and easily explained to others.

So when should you use @RISK? Anytime you make an analysis in
Excel that could be affected by uncertainty, you can and should use
@RISK. The applications in business, science and engineering are
practically unlimited and you can use your existing base of Excel
models. An @RISK analysis can stand alone, or be used to supply
results to other analyses. Consider the decisions and analyses you
make every day! If you've ever been concerned with the impact of
risk in these situations, you've just found a good use for @RISK!

Modeling Features

As an "add-in" to Microsoft Excel, @RISK "links" directly to Excel to
add Risk Analysis capabilities. The @RISK system provides all the
necessary tools for setting up, executing and viewing the results of
Risk Analyses. And @RISK works in a style you are familiar with —
Excel style menus and functions.

@RISK Functions

ii Welcome

@RISK allows you to define uncertain cell values in Excel as
probability distributions using functions. @RISK adds a set of new
functions to the Excel function set, each of which allows you to
specify a different distribution type for cell values. Distribution
functions can be added to any number of cells and formulas
throughout your worksheets and can include arguments which are
cell references and expressions — allowing extremely sophisticated
specification of uncertainty. To help you assign distributions to
uncertain values, @RISK includes a graphical pop-up window where
distributions can be previewed and added to formulas.

Available Distribution Types

The probability distributions provided by @RISK allow the
specification of nearly any type of uncertainty in cell values in your
spreadsheet. A cell containing the distribution function
NORMAL(10,10), for example, would return samples during a
simulation drawn from a normal distribution (mean = 10, standard
deviation = 10). Distribution functions are only invoked during a
simulation — in normal Excel operations, they show a single cell
value — just the same as Excel before @RISK. Available distribution
types include:

Beta BetaGeneral Beta-Subjective
Binomial Chi-Square Cumulative
Discrete Discrete Uniform Error Function
Erlang Exponential Extreme Value
Gamma General Geometric
Histogram Hypergeometric Inverse Gaussian
IntUniform Logistic Log-Logistic
Lognormal Lognormal2 Negative Binomial
Normal Pareto Pareto2
Pearson V Pearson VI PERT
Poisson Rayleigh Student's t
Triangular Trigen Uniform
Weibull

All distributions may be truncated to allow only samples within a
given ranges of values within the distribution. Also, many
distributions can also use alternate percentile parameters. This allows
you to specify values for specific percentile locations of an input
distribution as opposed to the traditional arguments used by the
distribution.

@RISK Simulation Analysis

@RISK has sophisticated capabilities for specifying and executing
simulations of Excel models. Both Monte Carlo and Latin Hypercube
sampling techniques are supported, and distributions of possible
results may be generated for any cell or range of cells in your
spreadsheet model. Both simulation options and the selection of
model outputs are entered with Windows style menus, dialog boxes
and use of the mouse.

Graphics

High resolution graphics are used to present the output distributions
from your @RISK simulations. Histograms, cumulative curves and
summary graphs for cell ranges all lead to a powerful presentation of
results. And all graphs may be displayed in Excel for further
enhancement and hard copy. An essentially unlimited number of
output distributions may be generated from a single simulation —
allowing for the analysis of even the largest and most complex
spreadsheets!

Welcome iii

Advanced Simulation Capabilities

The options available for controlling and executing a simulation in
@RISK are among the most powerful ever available. They include:

• Latin Hypercube or Monte Carlo sampling

• Any number of iterations per simulation

• Any number of simulations in a single analysis

• Animation of sampling and recalculation of the spreadsheet

• Seeding the random number generator

• Real time results and statistics during a simulation

High Resolution Graphic Displays

Product Execution Speed

@RISK graphs a probability distribution of possible results for each
output cell selected in @RISK. @RISK graphics include:

• Relative frequency distributions and cumulative probability

curves

• Summary graphs for multiple distributions across cell ranges

(for example, a worksheet row or column)

• Statistical reports on generated distributions

• Probability of occurrence for target values in a distribution

• Export of graphics as Windows metafiles for further

enhancement

Execution time is of critical importance because simulation is
extremely calculation intensive. @RISK is designed for the fastest
possible simulations through the use of advanced sampling
techniques.

iv Welcome

Table of Contents

Chapter 1: Getting Started 1

Introduction.........................................................................................3

Installation Instructions.....................................................................7

Quick Start.........................................................................................11

Chapter 2: An Overview to Risk Analysis 15

Introduction.......................................................................................17

What Is Risk? ....................................................................................19

What Is Risk Analysis? ....................................................................23

Developing an @RISK Model...........................................................25

Analyzing a Model with Simulation.................................................27

Making a Decision: Interpreting the Results.................................29

What Risk Analysis Can (Cannot) Do.............................................33

Chapter 3: Upgrade Guide 35

Introduction.......................................................................................37

New @RISK Model Window.............................................................39

New @RISK Add-in Features...........................................................43

New @RISK Results Window ..........................................................45

New Features in @RISK 4.5 vs @RISK 4.0.....................................49

Table of Contents v

Chapter 4: Getting to Know @RISK 57

A Quick Overview to @RISK...........................................................59

Setting Up and Simulating an @RISK Model.................................69

Chapter 5: @RISK Modeling Techniques 91

Introduction ...................................................................................... 93

Modeling Interest Rates and Other Trends ...................................95

Projecting Known Values into the Future...................................... 97

Modeling Uncertain or "Chance" Events.......................................99

Oil Wells and Insurance Claims....................................................101

Adding Uncertainty Around a Fixed Trend..................................103

Dependency Relationships ...........................................................105

Sensitivity Simulation....................................................................107

Simulating a New Product: The Hippo Example.........................109

Finding Value at Risk (VAR) of a Portfolio .................................. 119

Simulating the NCAA Tournament...............................................123

Chapter 6: Distribution Fitting 127

Overview ......................................................................................... 129

Define Input Data............................................................................131

Select Distributions To Fit............................................................. 135

Run The Fit......................................................................................139

Interpret the Results ......................................................................143

Using the Results of a Fit..............................................................151

vi Table of Contents

Chapter 7: @RISK Reference Guide 153

Introduction.....................................................................................161

Reference: @RISK Icons................................................................163

Reference: @RISK Add-In Menu Commands 173

File Menu .........................................................................................175

Model Menu.....................................................................................177

Simulate Menu ................................................................................189

Results Menu ..................................................................................203

Options Menu..................................................................................207

Advanced Analyses Menu .............................................................209

Goal Seek.........................................................................................211

Stress Analysis...............................................................................217

Advanced Sensitivity Analysis......................................................229

Reference: @RISK Model Window Commands 247

File Menu .........................................................................................249

Edit Menu.........................................................................................251

View Menu .......................................................................................253

Insert Menu......................................................................................255

Simulation Menu.............................................................................263

Model Menu.....................................................................................265

Correlation Menu............................................................................275

Fitting Menu.....................................................................................283

Graph Menu.....................................................................................309

Table of Contents vii

Artist Menu......................................................................................317

Window Menu .................................................................................323

Help Menu.......................................................................................325

Reference: @RISK Results Window Commands 327

File Menu.........................................................................................329

Edit Menu ........................................................................................331

View Menu.......................................................................................335

Insert Menu.....................................................................................337

Simulation Menu.............................................................................353

Results Menu.................................................................................. 355

Graph Menu .................................................................................... 361

Window Menu .................................................................................379

Help Menu.......................................................................................381

Reference: @RISK Functions 383

Introduction .................................................................................... 383

Reference: Distribution Functions...............................................401

Reference: Distribution Property Functions...............................429

Reference: Output Functions........................................................439

Reference: Statistics Functions ...................................................441

Reference: Supplemental Functions............................................ 447

Reference: Graphing Function ..................................................... 449

Reference: @RISK Macros 451

Overview ......................................................................................... 451

viii Table of Contents

Using VBA to Modify @RISK Settings and Enter Outputs.........453

Using VBA to Run Simulations, Get Results and Generate

Reports.........................................................................................455

Using VBA to Run Advanced Analyses........................................457

Appendix A: Sampling Methods 459

What is Sampling?..........................................................................459

Appendix B: Using @RISK With Other DecisionTools® 465

The DecisionTools Suite................................................................465

Palisade’s DecisionTools Case Study..........................................467

Introduction to TopRank®..............................................................471

Using @RISK with TopRank..........................................................475

Introduction to PrecisionTree™.....................................................479

Using @RISK with PrecisionTree..................................................483

Appendix C: Glossary 487

Appendix D: Recommended Readings 493

Readings by Category....................................................................493

Table of Contents ix

x Table of Contents

Chapter 1: Getting Started

Introduction.........................................................................................3

Checking Your Package ..........................................................................3

About This Version .................................................................................3

Working with your Operating Environment ......................................4

If You Need Help .....................................................................................4

@RISK System Requirements................................................................6

Installation Instructions.....................................................................7

General Installation Instructions..........................................................7

The DecisionTools Suite.........................................................................8

Setting Up the @RISK Icons or Shortcuts............................................9

Macro Security Warning Message on Startup ....................................9

Quick Start.........................................................................................11

On-line Tutorial......................................................................................11

Starting On Your Own ..........................................................................11

Quick Start with Your Own Spreadsheets ........................................12

Using @RISK 4.5 Spreadsheets in @RISK 3.5 or earlier..................13

Using @RISK 4.5 Spreadsheets in @RISK 4.0...................................13

@RISK 4.5 Help System © Palisade Corporation, 1999

Chapter 1: Getting Started 1

2 @RISK for Microsoft Excel

Introduction

This introduction describes the contents of your @RISK package and
shows you how to install @RISK and attach it to your copy of Microsoft
Excel 97 for Windows or higher.

Checking Your Package

Your @RISK package should contain:

The @RISK User’s Guide (this book) with:

• Getting Started

• Overview to Risk Analysis and @RISK

• Upgrade Guide

• Getting to Know @RISK

• @RISK Modeling Techniques

• Distribution Fitting

• @RISK Reference Guide

• Technical Appendices

The @RISK CD-ROM including:

• @RISK Program

• @RISK Tutorial

The @RISK Licensing Agreement

A complete listing of all files contained on the @RISK CD is contained in
the file INSTALL.LOG found in the PROGRAM FILES\PALISADE
\RISK45 directory on your hard disk.

If your package is not complete, please call your @RISK dealer or supplier
or contact Palisade Corporation directly at [phone]. If you want to
install @RISK from diskettes, please contact Palisade Corporation.

About This Version

This version of @RISK can be installed as a 32-bit program for Microsoft
Excel 97 or higher.

Chapter 1: Getting Started 3

Working with your Operating Environment

This User’s Guide assumes that you have a general knowledge of the
Windows operating system and Excel. In particular:

• You are familiar with your computer and using the mouse.

• You are familiar with terms such as icons, click, double-click, menu, window,

command and object.

• You understand basic concepts such as directory structures and file naming.

If You Need Help

Technical support is provided free of charge for all registered users of
@RISK with a current maintenance plan, or is available on a per incident
charge. To ensure that you are a registered user of @RISK, please register
online at www.palisade.com/html/register.html.

If you contact us by telephone, please have your serial number and User’s
Guide ready. We can offer better technical support if you are in front of
your computer and ready to work.

Before Calling

Before contacting technical support, please review the following checklist:

• Have you referred to the on-line help?

• Have you checked this User's Guide and reviewed the on-line multimedia

tutorial?

• Have you read the README.WRI file? It contains current information on

@RISK that may not be included in the manual.

• Can you duplicate the problem consistently? Can you duplicate the problem

on a different computer or with a different model?

• Have you looked at our site on the World Wide Web? It can be found at

http://www.palisade.com. Our Web site also contains the latest FAQ (a
searchable database of tech support questions and answers) and @RISK
patches in our Technical Support section. We recommend visiting our Web
site regularly for all the latest information on @RISK and other Palisade
software.

4 Introduction

Contacting Palisade

Palisade Corporation welcomes your questions, comments or suggestions
regarding @RISK. Contact our technical support staff using any of the
following methods:

• E-mail us at [e-mail].

• Telephone us at [phone] any weekday from 9:00 AM to 5:00 PM,

EST. Press 2 on a touch-tone phone to reach technical support.

• Fax us at [phone].

• Mail us a letter at:

Technical Support
Palisade Corporation
798 Cascadilla St
Ithaca, NY 14850 USA

If you want to contact Palisade Europe:

• E-mail us at [e-mail].

• Telephone us at +44 (0)2074269950 (UK).

• Fax us at +44(0)2073751229 (UK).

• Mail us a letter at:

Palisade Europe
Technical Support
The Blue House, Unit 1
30 Calvin Street
London E1 6NW UK

If you want to contact Palisade Asia-Pacific:

• E-mail us at [e-mail]

• Telephone us at +61299299799 (AU).

• Fax us at +61299543882(AU).

• Mail us a letter at:

Palisade Asia-Pacific Pty Limited
Suite 101, Level 1
8 Cliff Street
Milsons Point NSW 2061
AUSTRALIA

Regardless of how you contact us, please include the product name, exact
version and serial number. The exact version can be found by by selecting
the Help About command on the @RISK menu in Excel.

Chapter 1: Getting Started 5

Student Versions

Telephone support is not available with the student version of @RISK. If
you need help, we recommend the following alternatives:

• Consult with your professor or teaching assistant.

• Log-on to our site on the World Wide Web for answers to frequently asked

questions.

• Contact our technical support department via e-mail or fax.

@RISK System Requirements

System requirements for @RISK 4.5 for Microsoft Excel for Windows
include:

• Pentium PC or faster with a hard disk.

• Microsoft Windows 98 or higher or Windows NT 4.0 or higher.

• Microsoft Excel Version 97 or higher.

6 Introduction

Installation Instructions

General Installation Instructions

The Setup program copies the @RISK system files into a directory you
specify on your hard disk. Setup asks you for the location of the Excel
directory on your hard disk, so please note this information before
running Setup. Setup and @RISK require Microsoft Windows to run, so
be sure to start Windows before running these programs.

To run the Setup program in Windows 98 or higher:

1) Insert the @RISK CD-ROM in your CD-ROM drive

2) Click the Start button, click Settings and then click Control Panel

3) Double-click the Add/Remove Programs icon

4) On the Install/Uninstall tab, click the Install button

5) Follow the Setup instructions on the screen

If you encounter problems while installing @RISK, verify that there is
adequate space on the drive to which you’re trying to install. After
you’ve freed up adequate space, try rerunning the installation.

Authorizing Your Copy of @RISK

Chapter 1: Getting Started 7

Within 30 days of installing @RISK you need to authorize your copy of
@RISK.

Authorization can be done over the Internet by clicking the Authorize
Now button and following the prompts on the screen. Alternatively, you
can contact Palisade or Palisade Europe during normal business hours
and authorize your copy of @RISK over the phone.

An authorized copy of @RISK is licensed for use on a single computer
only. If you wish to move your copy of @RISK to a different computer,
please contact Palisade for instructions.

Removing @RISK from Your Computer

The DecisionTools Toolbar

Setup creates the file INSTALL.LOG in your @RISK directory. This file
lists the names and locations of all installed files. If you wish to remove
@RISK from your computer, use the Control Panel’s Add/Remove
Programs utility and select the entry for @RISK.

The DecisionTools Suite

@RISK for Excel is a member of the DecisionTools Suite, a set of products
for risk and decision analysis described in Appendix D: Using @RISK
With Other DecisionTools. The default installation procedure of @RISK
puts @RISK in a subdirectory of a main “Program Files\Palisade”
directory. This is quite similar to how Excel is often installed into a
subdirectory of a “Microsoft Office” directory.

One subdirectory of the Program Files\Palisade directory will be the
@RISK directory (by default called RISK45). This directory contains the
@RISK program files (RSKMODEL.EXE and RSKRSLTS.EXE) plus
example models and other files necessary for @RISK to run. Another
subdirectory of Program Files\Palisade is the SYSTEM directory which
contains files which are needed by every program in the DecisionTools
Suite, including common help files and program libraries.

When you launch one of the elements of the Suite (such as @RISK) from
its desktop icon, Excel will load a “DecisionTools Suite” toolbar which
contains one icon for each program of the Suite. This allows you to
launch any of the other products in the suite directly from Excel.

Note: In order for TopRank, the what-if analysis program in the
DecisionTools Suite, to work properly with @RISK, you must have
release TopRank 1.5e or higher.

8 Installation Instructions

Setting Up the @RISK Icons or Shortcuts

Creating the Shortcut in the Windows Taskbar

In Windows, setup automatically creates an @RISK command in the
Programs menu of the Taskbar. However, if problems are encountered
during Setup, or if you wish to do this manually another time, follow the
following directions.

1) Click the Start button, and then point to Settings.

2) Click Taskbar, and then click the Start Menu Programs tab.

3) Click Add, and then click Browse.

4) Locate the file RISK.EXE and double click it.

5) Click Next, and then double-click the menu on which you want the

program to appear.

6) Type the name “@RISK”, and then click Finish.

Macro Security Warning Message on Startup

Microsoft Office provides several security settings (under
Tools>Macro>Security) to keep unwanted or malicious macros from
being run in Office applications. A warning message appears each time
you attempt to load a file with macros, unless you use the lowest security
setting. To keep this message from appearing every time you run a
Palisade add-in, Palisade digitally signs their add-in files. Thus, once you
have specified Palisade Corporation as a trusted source, you can open
any Palisade add-in without warning messages. To do this:

• Click Always trust macros from this source when a Security

Warning dialog (such as the one below) is displayed when
starting @RISK.

Chapter 1: Getting Started 9

10 Installation Instructions

Quick Start

On-line Tutorial

In the on-line tutorial, @RISK experts guide you through sample models
in

streaming .WMV movie format. This tutorial is a multi-media

presentation on the main features of @RISK.

The system requirements for the tutorial are:

• Windows Media Player plug-in

• A computer with audio capability

The tutorial can be run by selecting the Start Menu/ Programs/ Palisade
DecisionTools/ Tutorials/ @RISK Tutorial and clicking on the file
RISK45.html.

Starting On Your Own

If you're in a hurry, or just want to explore @RISK on your own, here's a
quick way to get started.

After attaching @RISK according to the Installation instructions outlined
previously in this section:

1) Click the @RISK icon in the Windows Start Programs Palisade

DecisionTools group. If the Security Warning dialog is displayed, follow
the instructions in the section "Setting Palisade as a Trusted Source" in
this chapter.

2) Use the Excel Open command to open the example spreadsheet

FINANCE.XLS. The default location for the examples is
C:\PROGRAM FILES\PALISADE\RISK45\EXAMPLES.

3) Click the List icon on the @RISK Toolbar — the one on the Toolbar with

the red and blue arrow. The Outputs and Inputs list, listing the
distribution functions in the FINANCE worksheet along with your
output cell C10, NPV at 10%, is displayed.

4) Click the "Simulate" icon — the one with the red distribution curve.

You've just started a risk analysis on NPV for the FINANCE
worksheet. The Simulation analysis is underway. When it is complete,
your risk analysis results will be displayed.

Chapter 1: Getting Started 11

To make graphs for Risk Analysis results:

1) When results are shown, right click on the name of an output or input in

the Explorer list and select Histogram. A graph of simulation results for
the highlighted output or input cell will be displayed.

2) To modify a graph, click the right mouse button when the cursor is

located over the graph window. Select Graph Format from the pop-up
menu.

For all analyses, if you want to see @RISK "animate" its operation during
the simulation, turn the Simulation Settings dialog box Update Display
check box on or press the <Num Lock> key during the simulation. @RISK
then will show you how it changes your spreadsheet iteration by iteration
and generates results.

Quick Start with Your Own Spreadsheets

Working through the @RISK On-Line Tutorial and reading the @RISK
Reference Guide is the best method for preparing to use @RISK on your
own spreadsheets. However, if you're in a hurry, or just don't want to
work through the Tutorial, here is a quick step-by-step guide to using
@RISK with your own spreadsheets:

1) Click the @RISK icon in the Windows Start Programs Palisade

DecisionTools group.

2) If necessary, use the Excel Open command to open your spreadsheet

3) Examine your spreadsheet and locate those cells where uncertain

assumptions or inputs are located. You will substitute @RISK
distribution functions for these values.

4) Enter distribution functions for the uncertain inputs which reflect the

range of possible values and their likelihood of occurrence. Start with
the simple distribution types — such as UNIFORM, which just requires
a minimum and maximum possible value, or TRIANG which just
requires a minimum, most likely and maximum possible value.

5) Once you've entered your distributions, select the spreadsheet cell or

cells for which you wish to get simulation results and click the "Add
Output" icon — the one with the single red arrow — on the @RISK
Toolbar.

To run a simulation:

1) Click the "Simulate" icon — the one with the red distribution curve —

on the @RISK Toolbar. A simulation of your spreadsheet will be
executed and results displayed.

12 Quick Start

Using @RISK 4.5 Spreadsheets in @RISK 3.5 or earlier

@RISK 4.5 spreadsheets can only be used in @RISK 3.5 or earlier when the
simple forms of distribution functions are used. In the simple distribution
function format only required distribution parameters can be used. No
new @RISK 4.5 distribution property functions can be added. In addition,
RiskOutput functions must be removed and outputs reselected when
simulating in @RISK 3.5.

Using @RISK 4.5 Spreadsheets in @RISK 4.0

@RISK 4.5 spreadsheets can be used directly in @RISK 4.0 with the
following exceptions:

 Alternate Parameter functions, such as RiskNormalAlt, will not

work and will return an error.

 Cumulative Descending functions, such as RiskCumulD, will

not work and will return an error.

Chapter 1: Getting Started 13

14 Quick Start

Chapter 2: An Overview to Risk Analysis

Introduction.......................................................................................17

What Is Risk? ....................................................................................19

Characteristics of Risk...........................................................................19

The Need for Risk Analysis.................................................................20

Assessing and Quantifying Risk.........................................................21

Describing Risk with a Probability Distribution ............................22

What Is Risk Analysis? ....................................................................23

Developing an @RISK Model...........................................................25

Variables..................................................................................................25

Output Variables....................................................................................26

Analyzing a Model with Simulation.................................................27

Simulation ...............................................................................................27

How Simulation Works ........................................................................28

The Alternative to Simulation.............................................................28

Making a Decision: Interpreting the Results.................................29

Interpreting a Traditional Analysis....................................................29

Interpreting an @RISK Analysis.........................................................29

Individual Preference............................................................................30

The Distribution "Spread"....................................................................30

Skewness .................................................................................................32

What Risk Analysis Can (Cannot) Do.............................................33

Chapter 2: An Overview to Risk Analysis 15

16 Quick Start

Introduction

@RISK brings advanced modeling and Risk Analysis to Microsoft Excel.
You might wonder if what you do qualifies as modeling and/or would be
suitable for Risk Analysis. If you use data to solve problems, make
forecasts, develop strategies, or make decisions, then you definitely
should consider doing Risk Analysis.

Modeling is a catch-all phrase that usually means any type of activity
where you are trying to create a representation of a real life situation so
you can analyze it. Your representation, or model, can be used to examine
the situation, and hopefully help you understand what the future might
bring. If you've ever played "what-if" games with your project by
changing the values of various entries, you are well on your way to
understanding the importance of uncertainty in a modeling situation.

Okay, so you do analyses and make models — what is involved in
making these analyses and models explicitly incorporate risk? The
following discussion will try to answer this question. But don't worry,
you don't have to be an expert in statistics or decision theory to analyze
situations under risk, and you certainly don't have to be an expert to use
@RISK. We can't teach you everything in a few pages, but we'll get you
started. Once you begin using @RISK you'll automatically begin picking
up the type of expertise that can't be learned from a book.

Another purpose of this chapter is to give you an overview of how @RISK
works with your spreadsheet to perform analyses. You don't have to
know how @RISK works to use it successfully, but you might find some
explanations useful and interesting. This chapter discusses:

• What risk is and how it can be quantitatively assessed.

• The nature of Risk Analysis and the techniques used in @RISK.

• Running a simulation.

• Interpreting @RISK results.

• What Risk Analysis can and cannot do.

Chapter 2: An Overview to Risk Analysis 17

18 Introduction