Tools and Factors Contributing to Financial Engineering

Financial Engineering is vast field of study and is seen as very important expertise necessary for proper financial management. Let me introduce some important tools needed for financial engineering with a brief introduction to a team which is comprised of Financial Engineer and other important professionals.

To begin with, a Financial Engineer never works alone rather he is included as a part of huge team; its members, their number and expertise dependence upon the nature of works required for financial engineering. Mainly, an Accountant, a Tax specialist, one or two underwriters, traders, programmers, Financial Analysts, compliance officers and information service personals. Most important is to develop better communication and cultural environment so that each member can effectively and efficiently describe own point of view without any hesitation. All these members work together with a speed required for the solution of a task.

Tools Required for Financial Engineering:

In relation to tools requirement of financial engineering process, basically, two types of tools are used named

• Conceptual Tools

• Physical Tools

Conceptual Tools:

This category involves the combination of concepts and ideas that can be used in finance studies and are considered as formal disciplines. Mostly these types of tools are taught in business programs especially at graduation level. For instance, accounting relationships, hedging theory, valuation of theory, and portfolio theory are considered in curriculum.

Physical Tools:

Special process and instruments that are used by Financial Engineers in combination to gain a specific task or purpose are called as physical tools. The examples include variants, securities, futures, swaps, options, and equities.

Factors Influencing Financial Engineering:

Just like tools, two types of factors contribute to the growth process of financial engineering; environmental factors and intra firm factors

Environmental Factors:

The factors which are not controllable by any firm and are part of external environment are included in this category. Though they are external to business but they have direct impact on your business. Usually, PEST analysis is used to evaluate these factors and impact on any business. Most common examples are competitiveness, technological advancements, and new inventions, political and economical changes.

Intra Firm Factors:

All those factors of the company which can directly progress the financial engineering process are included in intra firm factors. Likewise, agency costs, accounting policies, risk aversion and liquidity needs are included in this type.

In conclusion, for an optimal success in finance management of a company, these tools and factors should be taken under consideration.

Advance Your Corporate Strategy Via Financial Engineering

To begin with, in this world of rapid technological advancements, the customer’s perceptions about their desired products and their criteria of selection of these items have been markedly changed. In my view, if a company is building a good relation with its customers in this era, it is managing a lot of process like satisfying the needs of all its stakeholders, and managing of operational, marketing, and financial departments at optimal level. As a business student, I can tell you that it requires much effort, most importantly when you come at financial aspect of each department. So a manager who is qualified with the subject of financial engineering can gear all the process and departments with good revenue and sales.

As most of the organizations have their finance departments and they deal with all the accounts of company but if every department constitutes of at least one Financial Engineer, it can enhance the company’s production at minimum resources. For example, five corporations having their headquarters; three in United States, one in Mexico and one in France were the seller and producers of gas, chemicals, cement, oil and electricity. Though their goals were very straight forward and they were using traditional approach to achieve those, but unfortunately nothing was working in the favor of companies’ objectives and every time a rise in cost or risks was revealing. What they did to tackle this tough situation? Nothing much; they just applied the same innovative approach by using different tools, concepts, and markets of financial engineering which I denoted before.

It is obvious from the example that financial engineering can have a marked impact on the corporate strategy of a firm and can result in good results if it is applied. Collaboration between general Staff Managers and Financial Engineers can provide a competitive edge to the company over its rivals; by differentiation of items via enhanced delivery and price plans, by an increase in the production capacity with variety of flexible alternatives as compared to capital investments, by alteration of characteristics of risks associated with products included in holding stock, and by creating a win-win situation for placement of strategic mergers on the track.

In summation, a company can increase its progress and can get a competitive advantage by application of Financial Engineering and immersion of this aspect at every level of organization. I would suggest following Financial Engineering tools and concepts to monitor evaluate and manipulate company’s process and management.

Financial Engineering Helps Understand Market Mechanism

Markets are filled with anomalies that diverge with standard theories. There are some investors who consider that market place is a trouble-free place and they can invest their money accordingly, at the end, they will certainly gain much profit. If any investor thinks this way, this is nothing but s/he is living in fool’s paradise for the reason that a financial market is a place where a lot of mechanism is being occurred continuously. The fact is the economic mechanism rests on an unstable schedule. That’s not to insist that it isn’t worth doing. In one perception it helps make it more attractive. In the event that you’re going to are employed in this field, you must understand that you’re not performing old fashioned technology at all, and that the classical approach doesn’t include the unimpeachable price it possesses. You need to think about if you can bear with that.

Financial engineering is applying science based mathematical models to judgments about saving, making an investment, lending, borrowing, and controlling danger. Financial mechanism is related to making use of those rules, constructively as well as synthetically, for a purpose. Thus, financial engineering is concerned with financial tools based on regulations, well coupled with heuristic or empirical specifications of more intricate factors; that is too difficult to gain.

Recently, the importance of financial engineering has increases for the reason that without having proper knowledge about financial engineering, a company cannot survive in the market place. There are some culprits are abusing financial engineering and they are exploiting the market. For their evil mechanism, many companies had to face dire consequences. Basically, stock markets are much more vulnerable due to evil mechanism.

Financial security is top priority to many marketers. They employ financial engineers so that they can handle the odd situation and save the respective company from the evil mechanism. Still many big companies are suffering from survival crises and they did everything to secure their existing, but eventually they did not make it. If they employed skilled financial engineers earlier, they would have saved their companies from evil mechanism. So, financial engineering should be layered above a good base of financial technology. It can be the study of the way to create practical financial products, converted bonds, warrants, synthetic CDOs, and so forth. That executes in wanted ways, not just at termination, yet throughout their lifespan.

The Rise of Algorithmic Trading

The rise of modern technology led to the surge of different applications in various fields. In finance, it led to the rise of algorithmic trading wherein computers are programmed to perform a trade under a predefined set of scenarios and corresponding instructions. It enables one to maximize their profit potential as compared to doing them manually.

Algorithmic trading , also known as black-box trading, allows one to enter his ideal trade orders, taking into consideration the price, the quantity and the timing. The program will then monitor the movements of the financial market. Once the stock price moves towards the range of his ideal average, it will execute either a buy or sell order.

Doing so provides a number of benefits to the trader. He or she need not monitor the price and the different market elements at play. Gone are the days when they have to manually put in an order. Trades will be done at the best possible price. There is no room for human error since the execution will be done in accordance to the instructions given. The trader won’t experience lost opportunities as a result of wrong timing since trade orders will be instantly placed as soon as the criteria are met.

Today, algorithmic trading is used in a number of investment transactions. Short term traders find automated trading convenient and highly beneficial. Systematic traders deem it useful in executing their hedge funds and pairs trading. Other investors focusing on mutual funds, insurance and pension funds would also prefer algorithmic trading. Traders who do not wish to affect the market pricing and other actors would use it to separate large volume trading into small orders.

Algorithmic trading is widely due to its diverse applications. It can be used in various strategies from taking advantage of arbitrage, inter-market spreads or by merely following the trends and speculations.

Financial Engineers Are Not Business People

Financial Engineers help make us realize just where our system is wrong and needs to be changed, but we have to as well understand the elements of the system they may exploit as well as the massive difficulties they will trigger to our economy if not proactively considered. With numerous bubbles and crumples of the survive 20 decades we have learned some instructions. We can’t do the same blunder again and again and assume distinct results. Similar to everybody else, we should see more people get back to functioning. In fact, we are buying companies as rapidly as we can to help add to the economic system as well as generate jobs. But we can’t permit our paralyzing desperation to generate jobs blind us from the exact issues that put our overall economy in this place.

In 2008, it created a cascading deliberating occasion which results in leading finance companies failing along with the wisest minds on Wall Street required to discard everything to accumulate paid cash, which in turn lead to an emergency of confidence together with deliberating that created the worst week in the history of the futures markets.

In 1987, funds, trying to capture out a different time level or two presumed they were being careful, purchasing insurance plan on leveraged share portfolios. Once the share charges on those portfolios started to drop, their insurance applications pushed them to dump all and promote share index options to raise cash, which experts claim bring about a crisis of confidence and deliberating that created the most unfortunate sole daytime melt down in the record of the futures markets.

No matter what money offered to stimulate the economy will probably be applied, while planned, by entrepreneurs and business people to create together with growing firms. Unfortunately, it will also function by Financial Engineers to search for a way to make huge revenue from much leveraged, threat laden money packaging. When you can borrow cheap dollars, get some resource that can be marked to an increasing market, borrow against the obtain and get something else and do it as many situations as possible. It’s in what way homeowners in a bull industry drove up real estate prices with a number of providing huge money. If you could do the same thing, but as opposed to with houses, with stocks or asset guaranteed securities, and instead of in thousands, do it right with billions upon billions and that means you might profits in the 10s of millions or more. You certainly aren’t going to explain to yourself that you could be developing the next big bubble that could rival 1929, or perhaps for future generations, would rival 2008.

Not wrong to run with bull markets and leverage to the hilt. That may be a good thing. But we have to make the positive side determined by purchases, and not by Financial Engineering. This really is the reason we will need to change our tax pass code. You want to encourage expenditure, not Financial Engineering. The monetary markets were formerly referred to as markets that made capital for businesses to commence as well as grow. These days, that is rarely the case. However, those instances are a tiny percentage of the market. While equities turn over it is floated numerous instances in a day, those are not investors buying and selling equities. Those are traders or financial engineers.

Financial Engineering in Port Reform

Money markets are highly diversified. Whether or not you should make use of such a source of finance depends upon many criteria, for instance, assets to be financed, the guarantees essential, mobility of use, as well as circumstances of acceptability by the monetary market. Financial technology of a project contains seeking out the best fine print of loan and cover for the project based on analysis of the financial limitations as well as risks of the market. Implementing financial engineering is a susceptible as well as intricate activity, susceptible on account of the determination of the monetary affiliates over periods that can be very long, complex on account of the multiplicity on top of raising sophistication of the financial gear available in the market. Additionally it is vital to recognize that the monetary project technology must to start with an agreement with a suitable logic that is definitely dictated by sound judgment plus a complete understanding of the concerns. It ought to not be based on a hope to make use of complex financial with cover mechanisms for their sakes.

As soon as the financial profitability of the venture has been identified, the SPC have to determine the structure of it is liabilities, that is, the value of its equity as well as quasi-equity and the value of its bad debts. In venture capital strategies, the building of the SPCs risks directly comes from the projects ability to service its financial obligations. The primary measures utilized in this value are: Capital structure ratio: the most commonly used ratio to determine the funding structure is: economic budget. Financial budget deals with most of the capital put in and located under the company’s control of the funds, to providers. In other words, it has permanent fiscal resources as well as financial institution developments. This ratio is calculated annually thereby provides a continuous view of the job’s ability to program its debt. It also enables the debt repayment profile to be modified in case the respects attained uncover too high a disparity in the course of the financial series.

NPV debt coverage ratio helps to be made between several methods of settling the mortgage loan in addition to presenting an international look at of the financial aspects of the venture. These several quantities permit one to assess from the start of the volume of credit card debt with minimal choice that is acceptable to the banks. Flows volume of For-ex equity plus quasi equity required for management of the project. If the financial partners aim in financing the venture is to permit the venture to benefit from a non recourse or perhaps minimal recourse mortgage loan, and then this means that the repayment ability of a project could be lower than the amount of external loan that the financial partners would like to obtain.

Importance of Quant Skills

A degree in quantitative finance shares its concerns over the application of various mathematical methods in order to the find out the solutions of problems in financial economics. Like many other programs this degree precisely focus on financial engineering, financial risk management, computational finance and mathematical finance. Generally the basic aim of these degrees is to prepare the related students to be Quantitative analysts which are also referred to as Quants. The basic task of Quantitative analyst is to analyze, structure, trade and keeping eye on investments. The master’s degree in the field of Quantitative finance was introduced in 1990. This master’s program is usually one and a half years in duration and sometimes also includes thesis. The requirements of this program are related to skills in Linear Algebra, differential equations and computer programming.

The target of the curriculum of this master’s degree is to develop quantitative skills, in addition to simultaneously develop the underlying finance theory. The component of quantitative skills comprises of skills in applied mathematics, theory of statistics, stochastic processes, numerical mathematical methods and computer programming. There are different institutes, which in addition to these skills also focus on economics. In financial theory, the focus is to deeply understand financial economics, addressing asset pricing and financial markets. These components are then integrated, addressing the modelling, valuation and hedging of equity derivatives, commodity derivatives, foreign exchange derivatives, and fixed income instruments and their related credit- and interest rate derivatives.

However, the title of the complete degree depends upon the emphasis. The major differences that exist between the programs are the distribution of the curriculum between Mathematical portion, quantitative techniques and financial applications. The theoretically oriented degrees are usually termed “Masters in Mathematical Finance” or “Masters in Financial Mathematics”  on the other hand the degrees that are based on practice and experimentation are names as “Masters in Financial Engineering” (MFE or MSFE), “Masters in Computational Finance” (MCF or MSCF), and sometimes even simply “Masters in Finance” (MFin). “Masters in Quantitative Finance” is the more general degree title, although “Masters in Quantitative Finance” degrees are often less theoretical and more practical. The practice oriented programs are often positioned as professional degrees. These program are quite different from the degrees like Master of Science in Finance (MSF), or an MBA in finance because the later degrees have a sole focus to produce finance generalists as opposed to “quants”, and therefore focus on corporate finance, accounting, equity valuation and portfolio management.

It is considerable that both of the above mentioned types of degrees have some overlap with the degrees in actuarial science and also in most of the cases both of these degrees are offered by the same department. There is similarly overlap with a Master of Financial Economics, although the emphasis is very different. The main of this degree is on underlying economics, and on the development of theoretical models, with the aim to prepare students for doctoral degrees. The curriculum therefore emphasizes coverage of financial theory, and of econometrics.

International Association for Quantative finance

International Association for Quantative finance (IAQF), which was previously known as International association of Financial Engineers (IAFE) is a non – profitable and professional society whose main task is foster the field of financial engineering. In order to achieve this, IAFE hosts several panel discussions all over the year to discuss the problems and issues that affect the industry from academic as well as professional angles. Since the establishment of IAFE in 1992, it has expanded a lot and at present discussions are being made in San Francisco, Boston and London.

Fischer Black Memorial Foundation (FBMF) is the important part of IAFE and it is regarded as the educational arm of it. With the International Association of Financial engineers focusing on the profession of financial engineering, the FBMF focus on the exposure of the field of financial engineering to students in order to help them work towards their career in the field/industry. It is also a proved fact that most of the times financial engineering is often underrepresented on university campuses. It is the duty of FBMF to bridge the gap between academia and the professional world. “How I become a Quant” is a very strong and useful tool in the hand of FBMF which brings a lot of professionals and experts from the field to the college and university campuses in order to share their experience with the student and thus removing their ambiguities and confusions. The FBMF also co-hosts (along with Society of Industrial and Applied Mathematics (SIAM) and New York University) an annual career fair that draws students from all over the United States to meet with the premier hiring companies in the industry. This is one of the only career fairs that is specifically for financial engineering and it is hugely popular with both the students and companies

The IAFE is also well known for the quality of its events and the prestige of the panelists who present. These events, in most cases are evening panels making a body of 3 – 4 speakers which include both; practitioners with years and years of experience and people from academics. In addition to these events, every year, there is one member of this field i.e. a financial engineer who is given the prestige award of “Financial engineer of the year” by International Association of Financial engineers. The selection of the winner is done through an exhaustive nomination and voting process and the list of former winners illustrates the high standards that the nominees must meet. Former financial of the year (FEOY) recipients continue to serve the IAFE as Senior Fellows and include such notable names as Myron Scholes, Robert Merton, William Sharpe, and Jonathan Ingersoll. The winner of the FEOY is celebrated at an annual Gala-dinner hosted by the IAFE and traditionally held at the United Nations building in New York City. This event is attended by many of the most distinguished members of the field and is one of the most important evenings on the IAFE calendar.

Grounds for the Appearance of Financial Engineering

Financial engineering concept is not old because the use of financial engineering in financial dealings started few decades ago especially when the USA was going through recession or “Great Depression”. In this context, the concept of financial engineering would seem relatively recent in terms of terminology and specialization. Nearly all definitions of financial engineering originated from the views of experts who develop theories, in particular possibly financial product designers in banking institutions, for this purpose, we find diverse definitions of the key phrase financial engineering. From the point of view of financial For-ex markets, the term financial engineering used to clarify the research of internet data accumulated from the money industry in a scientific way, and makes it possible for the use of instruments and even techniques of financial system for fiscal staff, in addition to an improved perception of the party dealers available in the market. It is of great importance to market traders due to the fact the accuracy and even speed of factual information crucial in making judgments.

Engineering is the use of monetary like forwards, futures, swaps, choices and related goods to restructure or rearrange cash runs in order to get individual monetary goals particularly the management of monetary risk. Economic system is not simply limited by corporate and institutional applications; the majority of the most productive money developments are actually guided at the user level like adaptable rate a mortgage, paid cash managing accounts, and various new forms of life insurance. Subsequently; financial engineering bears thus come to be the life body of such things to be undertaken. The progress and the formation of imaginative tailor made ways to fix problems in the loan. There are a number of theories about the advantages for the living and progression of financial invention, which is the foundation of financial engineering but could be summed up in as a response to certain restrictions hinder victory of fiscal targets like: liquidity, profit as well as reduce danger. This might be legal constraints, such as avoiding or deals legally certain transactions, or perhaps technological restrictions such as the issues of transporting specific products, or transform stuff to a different or perhaps sociable restriction, like taste for a certain form of merchandise to another.

Information Technology as well as the concept of the broad market is the emergence of networks in particular aided to enhance numerous international markets as well as different to the financial market place with a sizable, no temporal and spatial barriers and range up to the arrival of the info transferred.

An Overview

The term financial engineering is a huge term and simply it can be understood as multidisciplinary field that involves financial theory, tools of mathematics, methods of engineering and the practices of programming, Computer Science and Statistics. Or in other words it can also be understood as the applications of technical methods, especially mathematical and computational finance. So basically if anyone uses technical tools or techniques in the field of finance then he/she can be regarded as a financial engineer. For Example, a computer programmer working in a bank or a mathematician working in any economic bureau. The program of financial engineering, for the first time was introduced at New York University Poly – Technique School of Engineering in 1990’s by “International Association of financial Engineers” However despite its name, it cannot be included in the traditional fields of engineering.

A quantative analyst commonly known as “Quant” is someone who specializes in the application of statistical and mathematical techniques, especially those which are related to financial and risk management problem. The “Quant” can be regarded as a financial engineer. The only difference that can rise is that it is possible to be a theoretical Quant or a quant specialized only in finance, while the term financial engineer usually implies a practitioner with broad expertise. The first generation of who arrived in the Wall Street in United States of America in late 1970’s and early 1980’s were known as “Rocket Scientists”. The term “Rocket Scientist” is synonymous with financial engineer, however, it implies adventurousness and fondness of disruptive innovation. Rocket Scientists were usually trained in the fields of finance, Statistics and Applied Mathematics and they were known for risking their entire lives in risk taking. They were never hired for their mathematical talents or statistical skills and they either worked for themselves or applied the statistical and mathematical techniques to the traditional financial jobs. In contrary to this, the later generation of financial engineers were more likely to have doctorate degrees in Mathematics or Statistics and chose academics or non – financial fields as their careers.

In addition to appreciation and growth financial engineering also faced the blows of criticism from the experts of the same field. The most famous and important critique of financial engineering is Nassim Nicholas Taleb, who is a professor of financial engineering at New York University Poly – Technique School of Engineering. He argues that financial engineering causes the destruction of common sense leading to disaster. Similarly, like Taleb, Aaorn Brown raised the point of confusion between quants and regulators over the true meaning of ‘capital’, Felix Salmon pointed towards the problem in Gaussian copula, Ian Stewart criticized the Black-Scholes formula, Pablo Triana dislikes value at risk and Scott Patterson accused quantitative traders and later high-frequency traders. However, a gentler criticism came from Emanuel Derman who heads a financial engineering degree program at Columbia University who blames over-reliance on models for financial problems.