Finance: Capital Markets, Financial Management, and Investment Management

CHAPTER 12

Financial Engineering, Asset Securitization, and Project Financing

A specialty area in finance is the area of financial engineering. In fact, there are graduate degrees in this subject and even departments of business or engineering schools that carry this title. Yet, there is no standard definition of financial engineering. For example, Professor Neil Pearson provides the following two definitions of financial engineering for his courses in financial engineering and risk management at the University of Illinois:⁶⁶

(Definition 1) Financial engineering is the application of the mathematical tools commonly used in physics and engineering to financial problems, especially the pricing and hedging of derivative instruments.

 

(Definition 2) Financial engineering is the use of financial instruments such as forwards, futures, swaps, options, and related products to restructure or rearrange cash flows in order to achieve particular financial goals, particularly the management of financial risk. If we define financial engineering this way, it is almost synonymous with financial risk management.

The International Association of Financial Engineers (IAFE) defines financial engineering as follows:⁶⁷

• Financial engineering is the application of mathematical methods to the solution of problems in finance.

• It is also known as financial mathematics, mathematical finance, and computational finance.

• Financial engineering draws on tools from applied mathematics, computer science, ...