Financial Engineering

Financial engineering (FE) is an interdisciplinary field focusing on applications of

mathematical and statistical modeling and computational technology to problems in the
financial services industry. According to the report by the National Academy of Engineering
(2003),1 “Financial services are the foundation of a modern economy. They provide
mechanisms for assigning value, exchanging payment, and determining and distributing risk,
and they provide the essential underpinnings of global economic activity. The industry
provides the wherewithal for the capital investment that drives innovation and productivity
growth throughout the economy.” Important areas of FE include mathematical modeling of
market and credit risk, pricing and hedging of derivative securities used to manage risk, asset
allocation and portfolio management. Market risk is a risk of adverse changes in prices or
rates, such as interest rates, foreign exchange rates, stock prices, and commodity and energy
prices. Credit risk is a risk of default on a bond, loan, lease, pension or any other type of
financial obligation. Modern derivatives markets can be viewed as a global marketplace for
financial risks. The function of derivative markets is to facilitate financial risk transfer from
risk reducers (hedgers) to risk takers (investors)
Portfolio optimization problems constitute another major class of important problems in
financial engineering. Portfolio optimization problems occur throughout the financial services
industry as pension funds, mutual funds, insurance companies, university and foundation
endowments, and individual investors all face the fundamental problem of allocating their
capital across different securities in order to generate investment returns sufficient to achieve
a particular goal, such as meeting future pension liabilities. These problems are often very
complex owing to their dynamic and stochastic nature, their high dimensionality, and the
complexity of real-world constraints
How To Use Financial Engineering?

 Financial engineering is used across a broad range of tasks in the financial world.
Some of the areas where it is most commonly applied are the following:
 Corporate Finance
 Arbitrage Trading
 Technology and Algorithmic Finance
 Risk Management and Analytics
 Pricing of Options and other Financial Derivatives
 Behavioral Finance
 Creation of Structured Financial Products and Customized Financial Instruments
 Quantitative Portfolio Management
 Credit Risk and Credit Management
Types of financial engineering
Financial engineering covers a wide range of trading types, each requiring a different
approach to market analysis and forecasting. Here are common financial engineering types:
1. Derivatives trading
The derivative trading industry developed as financial engineers sought new strategies to
maximise profits. In this type of trading, financial agreements on their own don't hold any
apparent monetary value. These contractual agreements may relate to assets, interest rates or
indexes. The value of the derivatives depends on how the underlying entity performs over
time. By doing this, financial engineers have more opportunities to make a profit.
2. Foreign exchange market trading
Using foreign exchange markets for profit allows financial engineers to take advantage of
markets globally. The major trade in the foreign exchange market is currency exchange rates.
A company or organisation usually maintains a fund that holds different currency types from
different countries. By predicting the exchange rates between these currencies, a financial
engineer can predict when one currency may appreciate or decline in value. This benefits
companies, as their associated brokers can trade currencies with these predictions in mind,
maximising profits and limiting losses.

Key skills of a financial engineer

Successful financial engineers have a versatile skill set. The key skills they possess include:

Computer programming

Computer programming skills are critical to a financial engineer's ability to build market simulation
models. Having this skill is essential for predicting and analysing financial market behaviour. Financial
engineering employers often favour candidates with this skill because it is incredibly useful for capital
risk management in the business. You can improve your programming skills by learning more about
coding and debugging. Consider taking a short online course in computer programming to gain
expert advice and support.

1. Effective communication
Effective communication skills are necessary for financial engineers to explain their thoughts,
ideas and professional opinions to senior managers and executives. By being inquisitive,
financial engineers can also identify emerging financial trends and solve problems more
effectively. Try explaining complex issues to those unfamiliar with them to develop your
communication skills. Active listening, patience and vocal clarity can develop from this.
2. Mathematical skills
A financial engineer uses mathematical skills daily to test and implement new strategies for
generating profits and analysing capital risk. Financial engineers require strong mental maths,
statistical and theoretical knowledge to predict accurate market behaviour, increasing the
likeliness of a profitable trade. A financial engineer often develops these maths skills through
university or school training.
3. Problem-solving
Problem-solving is another important asset for financial engineers, as it shows employers you
are a capable and independent employee. For financial engineers, efficient problem solving
can minimise capital losses by quickly offering an effective trade solution. Having broad
knowledge of economics or finance is necessary for a financial engineer to become proficient
in this area.
Understanding how systems and processes work enables financial engineers to analyse how
and why the problem has occurred. This allows finding a solution quickly, without too much
risk affecting the company. Maintaining good organisation can help you improve your
problem-solving skills as it minimises distractions and allows you to focus on developing
solutions.
4. Computer science
Computer science is important for financial engineers, as it can implement automation,
algorithms, coding and other strategies for efficient data analysis. By creating algorithms,
financial engineers can detect and observe emerging trends in data. Using automation speeds
up the process of trading and data analysis. Consider dedicating some time to practice your
computer science skills and utilise free online resources.
5. Logical thinking
A logical thought process is essential for a financial engineer for problem-solving and risk
management. A financial engineer uses an analytical approach to finances with a scientific
and mathematical mindset. Having strong analytical skills is essential for financial engineers
to analyse trends and market activity. You can develop your logic skills by reading
educational books about critical thinking or playing problem-solving games, such as Sodoku
puzzles.
6. Knowledge of economics
Having excellent knowledge of economics is beneficial for all financial engineers, as it
provides more insight into market relations that can inform important decision-making. This
skill enables financial engineers to prepare more strategic plans and decision options in
response to market updates or contractual changes. This is key in understanding how politics
and public relations can affect the market, helping financial engineers with their predictions.
You can improve your economical awareness by reading financial magazines and books.
Requirements of a financial engineer
To become a financial engineer, you require the right qualifications and training. A university
degree in a relevant subject within the financial engineering field is necessary. Having hands-
on experience working in a professional setting may also allow you to develop your practical
knowledge, which employers value. Listed below are the key requirements for a successful
career in financial engineering:
7. Education
If you're still in high school, you may also consider taking maths and computer courses to
help expand your skill set and boost your knowledge. A high school diploma is often a
prerequisite for university, which is essential as most positions within financial engineering
require a bachelor's degree as a minimum. A master's degree in a finance or computer-related
subject may enhance your future career prospects. This prior experience can help you get
internships or work experience during or after university. Your familiarity with the technical
elements of computing may place you ahead of other candidates.
The most suitable bachelor's degrees for a career in financial engineering includes the
following:
 financial engineering
 accounting
 economics
 statistics
 Professional experience
Internships and voluntary roles are great ways to boost your financial engineering experience
in a professional setting. Employers value this experience, as it shows dedication, ambition
and passion. It also shows employers that you have developed a basic skill set in the industry,
which makes them more likely to take you on as an employee.