Financial Engineering & Risk Management

MFIM 7111

Tamirat Temesgen (PhD)

Addis Ababa University

School of Comerce

October 11, 2023

 Table of Contents

1 Introduction
Introduction to Financial Engineering and Risk Management
Programming language (Python)
Introduction
Introduction to Financial Engineering and Risk Management

What is Financial Engineering?

Financial engineering is the application of mathematical techniques

to design, develop and implement financial products, services and
processes.
It involves the use of financial theory, mathematics, computer
science, and engineering to create and manage financial instruments,
portfolios, and risk management strategies.
Introduction
Introduction to Financial Engineering and Risk Management

Examples of Financial Engineering

Derivatives (e.g. futures, options, swaps)

Structured products (e.g. collateralized debt obligations,
mortgage-backed securities)
Risk management strategies (e.g. hedging, diversification)
Introduction
Introduction to Financial Engineering and Risk Management

Benefits of Financial Engineering

Provides greater flexibility and customization of financial products to

meet specific needs and objectives.
Enables risk management and hedging of financial risks.
Increases liquidity in financial markets.
Introduction
Introduction to Financial Engineering and Risk Management

What is Risk Management?

Risk management is the process of identifying, assessing, and

controlling risks that arise from financial transactions or business
operations.
It involves the use of financial instruments and strategies to manage
the potential negative impact of these risks.
Introduction
Introduction to Financial Engineering and Risk Management

Types of Risks

Market risk: the risk of losses due to changes in market prices or

interest rates.
Credit risk: the risk of losses due to default by a borrower or
counterparty.
Operational risk: the risk of losses due to inadequate or failed
internal processes, people, and systems.
Liquidity risk: the risk of not being able to meet cash flow needs or
to sell assets quickly enough to meet obligations.
Introduction
Introduction to Financial Engineering and Risk Management

Risk Management Strategies

Hedging: using financial instruments to offset or reduce the impact

of a particular risk.
Diversification: spreading risk across different assets or investments.
Insurance: transferring risk to a third party through insurance
policies.
Derivatives: using derivatives to manage risks associated with
changes in market prices or interest rates.
Introduction
Introduction to Financial Engineering and Risk Management

Importance of Risk Management

Helps to minimize losses and protect assets.

Helps to ensure financial stability and sustainability.
Helps to maintain investor confidence and trust.
Helps to meet regulatory requirements and standards.
Introduction
Introduction to Financial Engineering and Risk Management

To summarize,
Financial engineering and risk management are essential components
of modern financial markets.
They provide a means of creating and managing financial
instruments and portfolios that meet specific needs and objectives,
while managing the associated risks.
Proper risk management is crucial for the long-term success and
sustainability of businesses and financial markets.
For further reading, (Beder and Marshall, 2011)
Introduction
Programming language (Python)

Why Python for Finance?

Ease of use
Open source www.python.org
Its is growing faster than predicted in the finance sector, giving way
to a faster and better analysis of stock market.
works quickly and integrate systems more effectively. Integration
with Excel.
Introduction
Programming language (Python)

Installation

Obtain a recent distribution for your machine; the most recent one
can always be found at www.python.org. As of to day the latest
version is Python 3.11.3.
Ubuntu: Most Linux distributions come with Python installed.
Check for the version. For Ubuntu operating system open the
terminal, write python3 -V and enter.
Anaconda: an alternative Python distribution, look at
https://www.anaconda.com/products/individual. If you
install it, you get not only Python, but also the R language and
other important packages.
Introduction
Programming language (Python)

Spyder

An integrated Development Environment is an enhanced text editor

that also provides features such as integrated code execution,
documentation, and debugging
Spyder is an excellent free IDE that is particularly well suited for
computing and data analysis using Python.
Other IDEs: e.g., Eclipse, PyCharm, Atom
For this course, Spyder IDE is recommended. It was specifically
created for Python programming and in particular for scientific
computing with Python.
Introduction
Programming language (Python)

The Jupyter Notebook

Write the command $ jupyter notebook.

Online resource with no installation:
https://colab.research.google.com/
Introduction
Programming language (Python)

Getting started

We will see a brief introduction to programming in Python. Lab1.ipynb

Introduction
Programming language (Python)

For further reading, you may look the following references:

(Hilpisch, 2014, 2018; Lewinson, 2020),
Beder, T. S. and Marshall, C. M. (2011). Financial engineering: the
evolution of a profession, volume 2. John Wiley & Sons.
Boudreault, M. and Renaud, J.-F. (2019). Actuarial finance: Derivatives,
quantitative Models and risk management. John Wiley & Sons.
Choe, G. H. et al. (2016). Stochastic analysis for finance with
simulations. Springer.
Hilpisch, Y. (2014). Python for Finance: Analyze big financial data. ”
O’Reilly Media, Inc.”.
Hilpisch, Y. (2018). Python for finance: mastering data-driven finance.
O’Reilly Media.
Hull, J. C. (2021). Options futures and other derivatives. Pearson
Education India.
Lewinson, E. (2020). Python for Finance Cookbook: Over 50 recipes for
applying modern Python libraries to financial data analysis. Packt
Publishing Ltd.