What Is Financial Engineering?

Financial engineering is an area of the financial sector that utilizes computer science, statistics, economics, and applied mathematics to solve quantitative financial problems♏. Financial engineering is used to analyze the financial markets, address current financial issues, and devise new and innovative financial products.

Financial engineering is sometimes referred to as quantitative analysis and is used by regular commercial banks, investment banks, insurance age꧟ncies, and h♈edge funds.

Understanding Financial Engineering

The financial industry is always coming up with new and innovative investment tools and prod🥀ucts for investors and companies. Most of the products have been developed through techniques in the field of financial engineering.

Using mathematical modeling and computer science, financial engineers are able to 𒈔test and issue new tools such as new meꦯthods of investment analysis, new debt offerings, new investments, new trading strategies, new financial models, etc.

Financial engineers run quantitative risk models to predict how an investment tool will perform, whether a new offering in the financial sector would be viable and profitable in the long run, and what types of risks are presentedꦇ in each product offering given the volatility of the markets.

Financial engineers work with insurance companies, asset management firms, hedge funds, and banks. Within these companies, financial engineers work in proprietary trading, risk management, portfolio management, derivatives and 澳洲幸运5官方开奖结果体彩网:options pricing, 澳洲幸运5官方开奖结果体彩网:structured products, and corporate finance departments.

Types of Financial Engineering

Derivatives Trading

While financial engineering uses stochastics, simulat▨ions, and analytics to design and implement new financial processes to solve problems in finance, the field also creates new strategies that companies can take advantage of to maximize corporate profits. For example, financial engineering has led to the explosion of derivative trading in the financial markets.

Since the 澳洲幸运5官方开奖结果体彩网:Cboe Options Exchange was formed in 1973 and two of the first financial engineers, Fischer Black and Myron Scholes, published their 澳洲幸运5官方开奖结果体彩网:option pricing model, trading in options and other derivatives has grown dramatically.

Through the regular options strategy where one c༒an either buy a call or put depending on whether they are bullish or bearish, finan🌃cial engineering has created new strategies within the options spectrum, providing more possibilities to hedge or make profits.

Examples of options strategies born out of financial engineering efforts include 澳洲幸运5官方开奖结果体彩网:married put, 澳洲幸运5官方开奖结果体彩网:protective collar, 澳洲幸运5官方开奖结果体彩网:long straddle, 澳洲幸运5官方开奖结果体彩网:short strangles, 澳洲幸运5官方开奖结果体彩网:butterfly spreads, etc.

Speculation

The field of financial engineering has also introduced 澳洲幸运5官方开奖结果体彩网:speculative vehicles in the markets. For example, instruments such as the 澳洲幸运5官方开奖结果体彩网:credit default swap (CDS) were initially created in the late 90s to provide insurance against 澳洲幸运5官方开奖结果体彩网:defaults on bond payments, such as municipal bonds.

However, these derivative products drew the attention of investment banks and speculators who realized they cou꧂ld make money from the monthly premium payments associated with a CDS by bett♑ing with them.

In effect, the seller or issuer of a CDS, usua🃏lly a bank, would receive monthly premium payments from the buyers of the swap. The value of a CDS is based on the survival of a company—the swap buyers are betting on the company going bankrupt and the sellers are in꧑suring the buyers against any negative event.

As long as the company remains in good financial standing, the issuing bank will keep getting paid monthly. If the company goes under, 澳洲幸运5官方开奖结果体彩网:the CDS buyers will cash in on the 澳洲幸运5官方开奖结果体彩网:credit event.

Criticism of Financial Engineering

Although financial engineering has revolutionized the financial markets, it played a role in the 2008 financial crisis. As the number of defaults on 澳洲幸运5官方开奖结果体彩网:subprime mortgage payments increased, more credit events were trig🌞gered. Credit default swap (CDS) issuers, that is banks, could not m💝ake the payments on these swaps since the defaults were happening almost at the same time.

Many corporate buyers that had taken out CDSs on 澳洲幸运5官方开奖结果体彩网:mortgage-backed securities (MBS) that they were heavily invested in, soon realized that the CDSs they held were worthless. To r♐eflect the loss of value, they reduced the value of assets on♛ their balance sheets, which led to more failures on a corporate level, and a subsequent economic recession.

Due to the 2008 global recession brought on by engineered structured products, financial engineering is considered to be a controversial field. However, it is apparent that this quantitative study has greatly improved the financial markets and proc🥃ess💎es by introducing innovation, rigor, and efficiency to the markets and industry.

The Bottom Line

Financial engineering is an integral part of the financial world. Using mathematics, statistics, computer science, and other related fields, financial engineering helps innovate the financial sector with new products, better ways to model and make investments, and improve the bottom line of financial institutions. Though it hꦆas generally revolutionized the financial field for the better, there have been times when it has contributed to econom🎃ic woes.