Financial Engineering: A Career for Adventure Lovers!
Posted by Dr.R.Radhika, Assistant Professor,HBS,GITAM University
‘Financial engineering’ involves the design, the development and the implementation of innovative financial instruments. It also discusses the processes, and the formulation of creative solutions to problems in finance. Hence, the study of ‘Financial Engineering’ leads to creative financial solutions that may involve a new customized financial instrument or a new financial instruments or security.
Financial engineering creates financial instruments on a continual basis. When many drawbacks are found in the existing instruments, new instruments are engineered to replace or take over from the existing financial instruments. When a product/service/contract is engineered before a need for the engineered features is felt, it is a hard sale. It takes quite a long time for the product to come into extensive use in the financial markets.
In simple words, ‘Financial engineering’ is the study of the process relating to ‘bundling and unbundling of securities like forwards, futures, swaps, options, and related products’. These securities used to restructure or rearrange cash inflows in order to achieve goals of the corporate entity.
Financial engineering involves a three dimensional approach viz., first dimension is ‘financial theory’, second dimension is ‘the tools of applied mathematics’, and the third is ‘the programming and engineering methodologies’. Hence study of this subject is useful for various issues like: pricing of financial products, trading and portfolio management decisions.
Financial engineers are often called upon to develop new instrument to secure the fund necessary for the operation of large scale businesses. Financial engineers are also employed in securities and derivatives product trading. They are particularly trained at developing trading strategies of an arbitrage nature. Arbitrage across instruments explains many new developments which have given rise to “synthetic” instruments and ‘repacking’ of cash flows.
A crucial function of the financial innovation is to help companies and households to manage risks. The discharge of this function depends on the type of financial products or contracts available to companies and households to hedge and take on exposures in close alignment with their individual risk preference and tolerance, as well as the capability of the institutions that make up the financial system to manage the risk inherent in these products. One must also bear in mind that imperfections within financial markets will affect the performance of these innovative financial products that may in turn limit their availability. One might call such assets ‘natural assets’ as the same instrument that is issued by the borrower is also held by the investor. In this example, the role of the financial system is simply to facilitate the intermediation between end-borrowers and end investors, and, in some cases, to provide a secondary market in the asset, intermediating between alternate end-investors.