A method that generates many random scenarios from a chosen model and revalues the portfolio in each. It handles non-linear positions but depends on the model and on enough runs.
Where you will meet it
Monte carlo simulation comes up in 16 learning outcome notes across the FRM syllabus.
A few of them:
Mortgages and Mortgage-Backed Securities FRM Part I · Financial markets and products
“Monte Carlo valuation handles the path dependence of MBS cash flows.”
Simulation and Bootstrapping FRM Part I · Quantitative analysis
“A Monte Carlo simulation approximates an expectation by averaging over random draws.”
Calculating and Applying VaR FRM Part I · Valuation and risk models
“Monte Carlo simulation specifies a stochastic process for each risk factor, for example geometric Brownian motion with a covariance matrix.”
Capital Structure in Banks FRM Part II · Credit risk measurement and management
“Because the combined distribution has no closed form, banks use Monte Carlo simulation or analytic approximations.”
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