Explanation

Correct Answer: B

Monte Carlo simulation involves assigning each key variable a statistical distribution. This is a fundamental characteristic of the method, where variables are modeled with specific probability distributions.

Analysis of Other Options:

• A: Incorrect - Randomly selecting returns from historical periods describes historical simulation or bootstrapping, not Monte Carlo simulation.
• C: Incorrect - While historical data may be used to calibrate distributions, Monte Carlo simulation does not inherently assume that past returns guide future returns. It generates scenarios based on statistical distributions.

Key Points:

• Monte Carlo simulation models variables with probability distributions
• It generates random scenarios rather than resampling historical data
• The method can incorporate various distributional assumptions