What Is Financial Engineering?

Financial engineering is an area of the fi🎶nancial 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 quantitativeꦕ analysis and is used by regular commercial banks, investment banks, insurance agencies, and hedge fuཧnds.

Understanding Financial Engineering

The financial industry is always coming up with new and i𓄧nnovative investment tools and products 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 test and is🐲sue new tools such as new methods 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 wo𓂃uld be viable and profitable in the long run, and what types of risks are presented in each product 𓆉offering 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开奖号码历史查询:options pricing, 澳洲幸运5开奖号码历史查询:structured products, and corporate finance departments.

Types of Financial Engineering

Derivatives Trading

While financial engineering uses stochastics, simulations, 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 ಌthe financial markets.

Since the 澳洲幸运5开奖号码历史查询: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开奖号码历史查询:option pricing model, trading in options and other derivatives has grown dramatically.

Through the regular options strategy where one can either buy a call or put depending on whet🌼her they are bullish or bearish, financial🍬 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开奖号码历史查询:married put, 澳洲幸运5开奖号码历史查询:protective collar, 澳洲幸运5开奖号码历史查询:long straddle, 澳洲幸运5开奖号码历史查询:short strangles, 澳洲幸运5开奖号码历史查询:butterfly spreads, etc.

Speculation

The field of financial engineering has also introduced 澳洲幸运5开奖号码历史查询:speculative vehicles in the markets. For example, instruments such as the 澳洲幸运5开奖号码历史查询:credit default swap (CDS) were initially created in the late 90s to provide insurance against 澳洲幸运5开奖号码历史查询:defaults on bond payments, such as municipal bonds.

However, these derivative products drew the attention of investment banks and speculators who realized the✱y could make money from the monthly premium payments associated with a CDS by betting with them.

In effect, the seller or issuer of a CDS, usually ဣa 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 insuring 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开奖号码历史查询:the CDS buyers will cash in on the 澳洲幸运5开奖号码历史查询: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开奖号码历史查询:subprime mortgage payments increased, more credit events were trig💛gered. Credit default swap (CDS) issuers, that is banks, could not make 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开奖号码历史查询:mortgage-backed securities (MBS) that they were heavily invested in, soon realized that the CDSs they held were worthless. To reflect 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 2🐼008 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 improv𓆉ed the financial markets and processes 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 mode🐭l and make investments, and improve the bottom line of financial institutions. Though it has generally revolutionized the financial field for the bette🅠r, there have been times when it has contributed to economic woes.