FINANCIAL ENGINEERING Introduction: Financial engineering is the application of investment technology in an effort to solve financial problems.

Financial engineers are employed by investment banks, commercial banks, a variety of other financial intermediaries, and nonfinancial corporations. Financial engineers are responsible for most financial innovation. It is difficult to overstate the importance of such innovation over the last fifteen years. Financial engineers must be trained in both the conceptual tools that constitute financial theory and in the physical tools that take the form of financial instruments and processes. Financial engineering should not be confused with financial analysis. Analysts decompose structures in order to understand them. This is an important step in identifying the existence of a problem and in getting to its root cause. While this is a critical step in financial engineering, it is only the first step. The engineer uses his or her knowledge of the relevant theory, instruments, and process together with his or her understanding of the problem to engineer a solution to the problem. Factors contributing to the Growth: Financial engineering over the last 20 years has been driven by both environmental factors which are external to the firm and by intra-firm factors which are those that are internal to the firm. The environmental factors include increased price volatility in most market sectors, a general globalization of the markets, tax asymmetries, developments in technology, and advances in financial theory, regulatory change, increased competition, and reductions in information and transaction costs. The intra-firm factors include the liquidity needs of business, the risk aversion of managers and owners, reduced profit margins; agency costs greater levels of quantitative sophistication among investment managers, land more formal training of senior level personnel. While lulls in the pace of financial innovation will likely occur, financial engineering is unlikely to disappear. The forces that have given birth to this profession will continue to drive it. There are given birth great opportunities to be seized and great pitfalls to be avoided. The Knowledge Base: Financial engineers are not clones of one another, and the skills required of one are not necessarily the skills required of another. While almost all financial engineers have a good foundation in economic and financial theory, basic accounting, basic mathematics and statistics, and at least some modeling skill, others have much greater levels of skill in one or more of these areas. Modern financial engineers must be versed in the relevant technology and understand how it is used in their profession. Some will use it extensively and others only occasionally. Financial engineers often function as part of a team. This requires good interpersonal skills and the ability to communicate effectively. These skills become particularly important when a financial engineer must consult with a specialist in one of the many areas that impinge on the work of the financial engineer.