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Financial Engineering: The Evolution of a Profession

Book Description

FINANCIAL ENGINEERING

The Robert W. Kolb Series in Finance is an unparalleled source of information dedicated to the most important issues in modern finance. Each book focuses on a specific topic in the field of finance and contains contributed chapters from both respected academics and experienced financial professionals. As part of the Robert W. Kolb Series in Finance, Financial Engineering aims to provide a comprehensive understanding of this important discipline by examining its fundamentals, the newest financial products, and disseminating cutting-edge research.

A contributed volume of distinguished practitioners and academics, Financial Engineering details the different participants, developments, and products of various markets—from fixed income, equity, and derivatives to foreign exchange. Also included within these pages are comprehensive case studies that reveal the various issues associated with financial engineering. Through them, you'll gain instant insights from the stories of Countrywide (mortgages), Société Générale and Barings (derivatives), the Allstate Corporation (fixed income), AIG, and many others. There is also a companion website with details from the editors' survey of financial engineering programs around the globe, as well as a glossary of key terms from the book.

Financial engineering is an evolving field in constant revision. Success, innovation, and profitability in such a dynamic area require being at the forefront of research as new products and models are introduced and implemented. If you want to enhance your understanding of this discipline, take the time to learn from the experts gathered here.

"The ebook version does not provide access to the companion files".

Table of Contents

  1. Cover
  2. Series
  3. Title Page
  4. Copyright
  5. Dedication
  6. Introduction
    1. THEME 1: DERIVATIVES WILL CONTINUE TO PLAY A CRITICAL, VALUABLE, AND PERMANENT ROLE IN THE GLOBAL CAPITAL MARKETS
    2. THEME 2: RISK MEASUREMENT AND MANAGEMENT WILL CHANGE SUBSTANTIALLY FOLLOWING LESSONS LEARNED FROM THE MELTDOWN THAT MANIFESTED IN 2007
    3. THEME 3: FINANCIALLY-ENGINEERED SECURITIES AND STRATEGIES WILL EVOLVE TO INCLUDE MORE TRANSPARENCY AND BETTER WARNING LABELS
    4. THEME 4: THE DEGREE TO WHICH INCREASED REGULATION WILL STYMIE FINANCIAL ENGINEERING AND INNOVATION IS UNCERTAIN
  7. Part I: Overview
    1. Chapter 1: The History of Financial Engineering from Inception to Today*
      1. WHAT IS FINANCIAL ENGINEERING?
      2. WHY DIDN'T FINANCIAL ENGINEERING START SOONER?
      3. INCEPTION AND THE EARLY STAGES (1970 TO 1997)
      4. THE MASSIVE GROWTH PERIOD (1998 TO 2006)
      5. THE RATIONALIZATION PERIOD (2007 TO DATE, ONGOING)
      6. HISTORICAL READINGS
      7. ABOUT THE AUTHOR
    2. Chapter 2: Careers in Financial Engineering
      1. INTRODUCTION
      2. A WORLD OF OPPORTUNITIES
      3. FUNCTIONAL AREAS
      4. SPECIFIC CAREER PATHS
      5. USING THE TABLES
      6. COMPUTER PROGRAMMING SKILLS
      7. CONCLUSION
      8. ABOUT THE AUTHOR
    3. Chapter 3: A Profile of Programs and Curricula with a Financial Engineering Component
      1. INTRODUCTION
      2. BACKGROUND INFORMATION ON FINANCIAL ENGINEERING PROGRAMS
      3. CURRICULA
      4. JOB PLACEMENT
      5. CONCLUSION
      6. APPENDIX: PROGRAMS CONTACTED
      7. ABOUT THE AUTHOR
  8. Part II: Financial Engineering and the Evolution of Major Markets
    1. Chapter 4: The Fixed Income Market
      1. INTRODUCTION
      2. THE CASH MARKETS
      3. DERIVATIVES MARKETS
      4. PRICE–YIELD RELATIONSHIP
      5. THE YIELD CURVE
      6. INTEREST RATE MODELS
      7. ABOUT THE AUTHOR
    2. Chapter 5: The U.S. Mortgage Market
      1. INTRODUCTION
      2. A BRIEF HISTORY OF THE ORIGIN OF THE MARKET FOR MORTGAGE-BACKED SECURITIES
      3. AGENCY MORTGAGE PASS-THROUGH SECURITIES
      4. PRICING MORTGAGE-BACKED SECURITIES
      5. BEYOND PASS-THROUGHS: COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS)
      6. THE NON-AGENCY MARKET
      7. FINANCIAL ENGINEERING AND THE FUTURE OF THE SECONDARY MORTGAGE MARKET
      8. A NOTE ON THE GLOBAL GROWTH OF THE MORTGAGE MARKET
      9. ABOUT THE AUTHOR
    3. Chapter 6: The Equity Market
      1. INTRODUCTION
      2. CASH MARKET—ORIGINS
      3. EQUITY DERIVATIVES
      4. DECLINING TRADING COSTS INCREASE FINANCIAL ENGINEERING OPPORTUNITIES, AND FINANCIAL ENGINEERING OFTEN REDUCES TRADING COSTS
      5. ARBITRAGE COMPLEXES
      6. EQUITY STRUCTURED PRODUCTS AND EXCHANGE-TRADED FUNDS (ETFS)
      7. PORTFOLIO TRADING AND STOCK INDEX FUTURES CONTRACTS
      8. SHAREHOLDER PROTECTION
      9. TAX EFFICIENCY
      10. THOUGHTS ON IMPROVING ETFS
      11. ABOUT THE AUTHORS
    4. Chapter 7: The Foreign Exchange Market
      1. INTRODUCTION
      2. HOW FOREX IS TRADED: THE INSTITUTIONAL FRAMEWORK
      3. HOW ARE EXCHANGE RATES DETERMINED?
      4. DERIVATIVES AND THE PRIVATIZATION OF FOREX RISK MANAGEMENT
      5. ABOUT THE AUTHOR
    5. Chapter 8: The Commodity Market
      1. HISTORICAL PERSPECTIVE
      2. EXCHANGE-TRADED VERSUS OTC COMMODITY PRODUCTS
      3. FUTURES CONTRACTS
      4. RISK MANAGEMENT WITH COMMODITY FUTURES/OPTIONS
      5. COMMODITY SWAPS
      6. COMMODITY OPTIONS
      7. FINANCIAL ENGINEERING IN COMMODITIES MARKETS
      8. COMMODITY ETFS
      9. REGULATION OF COMMODITY MARKETS
      10. A FINANCIAL ENGINEERING EXERCISE: SYNTHESIZING BARTER
      11. ABOUT THE AUTHORS
    6. Chapter 9: Credit Markets
      1. INTRODUCTION
      2. PREDECESSOR PRODUCTS
      3. APPLICATIONS
      4. FIRST-GENERATION PRODUCTS: 1992–2000
      5. SECOND-GENERATION PRODUCTS: 2001–2007
      6. GOING FORWARD
      7. ABOUT THE AUTHOR
  9. Part III: Key Applications of Financial Engineering
    1. Chapter 10: Securitized Products
      1. INTRODUCTION
      2. ORIGINS OF SECURITIZATION
      3. MARKET SIZE AND SEGMENTS
      4. TRANSACTION PROCESS
      5. CREDIT RATINGS
      6. ABOUT THE AUTHOR
    2. Chapter 11: Structured Products
      1. INTRODUCTION
      2. A HISTORY
      3. EQUITIES
      4. CREDIT
      5. CONCLUSION
      6. ABOUT THE AUTHOR
    3. Chapter 12: Thoughts on Retooling Risk Management
      1. INTRODUCTION
      2. REVISITING THE TONE AT THE TOP OF THE ORGANIZATION
      3. CONDUCT A BOARD-LEVEL REVIEW OF VAR AND STRESS TESTING
      4. ADDING WARNING LABELS TO RISK REPORTS
      5. CONCLUSION AND AN ENDNOTE
      6. ABOUT THE AUTHORS
    4. Chapter 13: Financial Engineering and Macroeconomic Innovation
      1. INTRODUCTION
      2. A REFRESHER ON MONETARY POLICY
      3. POLICY TOOLS OF CENTRAL BANKS
      4. THE FEDERAL RESERVE AND THE LIQUIDITY CRISIS
      5. EXPRESSING A VIEW: INVESTING WITH PRICE INSTABILITY
      6. MACROECONOMIC DERIVATIVES
      7. ABOUT THE AUTHORS
    5. Chapter 14: Independent Valuation for Financially-Engineered Products
      1. INTRODUCTION
      2. THE UNIVERSE OF FINANCIALLY ENGINEERED PRODUCTS
      3. THE FAIR VALUE HIERARCHY
      4. MODELING ALTERNATIVES: CDOS
      5. INCORPORATING THE EFFECTS OF ILLIQUIDITY IN VALUATION
      6. THE ROLE OF THIRD-PARTY VALUATION PROVIDERS
      7. CONCLUSION
      8. ABOUT THE AUTHORS
    6. Chapter 15: Quantitative Trading in Equities
      1. INTRODUCTION
      2. STRUCTURE OF QUANTITATIVE EQUITY MODELS
      3. OUTLOOK
      4. ABOUT THE AUTHOR
    7. Chapter 16: Systematic Trading in Foreign Exchange
      1. INTRODUCTION
      2. IS SYSTEMATIC TRADING JUST FOR GEEKS AND QUANTS?
      3. WHAT CAN SYSTEMATIC TRADING ANALYSIS DO FOR ME?
      4. ADVANTAGES AND LIMITATIONS OF SYSTEMATIC TRADING
      5. WHAT IS NECESSARY FOR A SYSTEM TO WORK?
      6. WHAT CAN I REASONABLY EXPECT?
      7. USES OF SYSTEMATIC TRADING METHODS
      8. EVALUATION OF SYSTEMATIC TRADING IDEAS AND PRODUCTS
      9. ABOUT THE AUTHORS
  10. Part IV: Case Studies in Financial Engineering: The Good, the Bad, and the Ugly
    1. Chapter 17: Case Studies Introduction
      1. INTRODUCTION
      2. ABOUT THE AUTHOR
    2. Chapter 18: Mortgage Case Studies: Countrywide and Northern Rock
      1. CASE STUDY ONE: COUNTRYWIDE FINANCIAL1
      2. CASE STUDY TWO: NORTHERN ROCK2
      3. ABOUT THE AUTHOR
    3. Chapter 19: Derivatives Case Studies: SocGen, Barings, and Allied Irish/Allfirst
      1. CASE STUDY ONE: SOCIéTé GéNéRALE1
      2. CASE STUDY TWO: BARINGS2
      3. CASE STUDY THREE: ALLIED IRISH/ALLFIRST3
      4. ABOUT THE AUTHOR
    4. Chapter 20: Fixed Income Case Study, Swap Market: The Allstate Corporation
      1. THE ALLSTATE CORPORATION1
      2. ABOUT THE AUTHOR
    5. Chapter 21: Lessons from Funds: LTCM, Florida, and Orange County
      1. CASE STUDY ONE: LONG-TERM CAPITAL MANAGEMENT1
      2. CASE STUDY TWO: FLORIDA STATE BOARD OF ADMINISTRATION2
      3. CASE STUDY THREE: ORANGE COUNTY MARKET RISK EVENT3
      4. ABOUT THE AUTHOR
    6. Chapter 22: Credit Derivatives Case Studies: AIG and Merrill Lynch
      1. CASE STUDY ONE: AMERICAN INTERNATIONAL GROUP (AIG)1
      2. CASE STUDY TWO: MERRILL LYNCH2
      3. ABOUT THE AUTHOR
  11. Part V: Special Topics in Financial Engineering
    1. Chapter 23: Performance Fees
      1. INTRODUCTION
      2. PERFORMANCE FEES
      3. HEDGE FUND VERSUS MUTUAL FUND FEES
      4. ABOUT THE AUTHOR
    2. Chapter 24: Musings About Hedging
      1. THE HEDGING ORIENTATION
      2. THE TRADING ORIENTATION
      3. THE ACCOUNTING ORIENTATION
      4. CONCLUSION
      5. ABOUT THE AUTHOR
    3. Chapter 25: Operational Risk
      1. INTRODUCTION AND CURRENT STATE OF KNOWLEDGE
      2. A BRIEF HISTORY OF THE BUSINESS OF OPERATIONAL RISK
      3. OVERVIEW OF SUBJECT
      4. MORE ON HEDGE FUNDS AND OPERATIONAL RISK
      5. MITIGATING OPERATIONAL RISK
      6. ABOUT THE AUTHOR
    4. Chapter 26: Legal Risk
      1. INTRODUCTION
      2. KEY LEGAL RISKS
      3. MITIGATING LEGAL RISK
      4. THE REGULATORY LANDSCAPE
      5. REGULATORY EVOLUTION
      6. ABOUT THE AUTHOR
    5. Chapter 27: Portable Alpha
      1. INTRODUCTION
      2. WHAT IS PORTABLE ALPHA?
      3. THE APPEAL OF PORTABLE ALPHA
      4. ABOUT THE AUTHORS
    6. Chapter 28: The No-Arbitrage Condition in Financial Engineering: Its Use and Misuse
      1. INTRODUCTION
      2. THE OPTIMIZATION FORMULATION
      3. POSSIBLE SOLUTIONS
      4. MARKET EQUILIBRIUM
      5. THE DUAL PROBLEM
      6. PRICING RELATIONSHIPS
      7. PERFECT CAPITAL MARKETS
      8. A TWO-STATE, SINGLE-PERIOD EXAMPLE
      9. INCORPORATING THE EVENT OF DEFAULT
      10. A MULTIPERIOD FRAMEWORK
      11. INCORPORATING DEFAULT
      12. CONCLUSION
      13. ABOUT THE AUTHOR
    7. Chapter 29: Influencing Financial Innovation: The Management of Systemic Risks and the Role of the Public Sector
      1. INTRODUCTION
      2. FINANCIAL MARKET INNOVATION
      3. INCOMPLETE MARKETS FOR INSURANCE RISK
      4. PUBLIC POLICY CONSIDERATIONS
      5. CONCLUSION
      6. ABOUT THE AUTHORS
  12. Part VI: Appendices
    1. Appendix A: IT Tools for Financial Asset Management and Engineering
      1. INTRODUCTION
      2. BASIC MS-EXCEL® TOOLS
      3. MATHEMATICA®, GAUSS™, MAPLE®, AND MATLAB®2
      4. BLOOMBERG®3, INFORMATION, AND THE API
      5. MORE COMPLEX MS-EXCEL COMPUTATIONS
      6. MONTE CARLO SIMULATION
      7. CONCLUSION
      8. READER RESOURCES
      9. ABOUT THE AUTHOR
    2. Appendix B: About the Companion Website
      1. MORE ABOUT THE SURVEY
  13. About the Editors
  14. Index