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Risk Management in Trading: Techniques to Drive Profitability of Hedge Funds and Trading Desks by Davis Edwards

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CHAPTER 3 Financial Mathematics

Risk managers and traders use mathematics to concisely describe trading strategies and the risks involved with trading. This notation can be overwhelming at points. Learning to read financial notation is much like learning a foreign language. The complexity of learning the language of finance is compounded by the fact that financial mathematics incorporates terminology from many branches of mathematics including algebra, probability, statistics, and calculus. This chapter provides a brief survey of these disciplines and their associated terminology.

OVERVIEW

Since the late 1970s, trading has become heavily dependent upon mathematics to describe and analyze investment opportunities. To meet this need, hedge funds and other financial firms have heavily recruited mathematicians, engineers, and scientists for trading positions. These transplanted employees continued to advance the mathematics used by the financial industry. This has helped propel the hedge fund industry into the twenty-first century. Unfortunately, this trend has also brought an extensive amount of financial jargon into trading. Learning to read financial notation is much like learning a foreign language.

This section introduces mathematical concepts and terminology used by traders and risk managers. Financial mathematics uses terminology pulled from many financial disciplines. Some of the branches of mathematics that contribute terminology to trading and risk management are:

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