Contents

Cover

Series

Title Page

Copyright

Dedication

Introduction

THEME 1: DERIVATIVES WILL CONTINUE TO PLAY A CRITICAL, VALUABLE, AND PERMANENT ROLE IN THE GLOBAL CAPITAL MARKETS

THEME 2: RISK MEASUREMENT AND MANAGEMENT WILL CHANGE SUBSTANTIALLY FOLLOWING LESSONS LEARNED FROM THE MELTDOWN THAT MANIFESTED IN 2007

THEME 3: FINANCIALLY-ENGINEERED SECURITIES AND STRATEGIES WILL EVOLVE TO INCLUDE MORE TRANSPARENCY AND BETTER WARNING LABELS

THEME 4: THE DEGREE TO WHICH INCREASED REGULATION WILL STYMIE FINANCIAL ENGINEERING AND INNOVATION IS UNCERTAIN

Part I: Overview

Chapter 1: The History of Financial Engineering from Inception to Today*

WHAT IS FINANCIAL ENGINEERING?

WHY DIDN'T FINANCIAL ENGINEERING START SOONER?

INCEPTION AND THE EARLY STAGES (1970 TO 1997)

THE MASSIVE GROWTH PERIOD (1998 TO 2006)

THE RATIONALIZATION PERIOD (2007 TO DATE, ONGOING)

HISTORICAL READINGS

ABOUT THE AUTHOR

Chapter 2: Careers in Financial Engineering

INTRODUCTION

A WORLD OF OPPORTUNITIES

FUNCTIONAL AREAS

SPECIFIC CAREER PATHS

USING THE TABLES

COMPUTER PROGRAMMING SKILLS

CONCLUSION

ABOUT THE AUTHOR

Chapter 3: A Profile of Programs and Curricula with a Financial Engineering Component

INTRODUCTION

BACKGROUND INFORMATION ON FINANCIAL ENGINEERING PROGRAMS

CURRICULA

JOB PLACEMENT

CONCLUSION

APPENDIX: PROGRAMS CONTACTED

ABOUT THE AUTHOR

Part II: Financial Engineering and the Evolution of Major Markets

Chapter 4: The Fixed Income Market

INTRODUCTION

THE CASH MARKETS

DERIVATIVES MARKETS

PRICE–YIELD RELATIONSHIP

THE YIELD CURVE

INTEREST RATE MODELS

ABOUT THE AUTHOR

Chapter 5: The U.S. Mortgage Market

INTRODUCTION

A BRIEF HISTORY OF THE ORIGIN OF THE MARKET FOR MORTGAGE-BACKED SECURITIES

AGENCY MORTGAGE PASS-THROUGH SECURITIES

PRICING MORTGAGE-BACKED SECURITIES

BEYOND PASS-THROUGHS: COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS)

THE NON-AGENCY MARKET

FINANCIAL ENGINEERING AND THE FUTURE OF THE SECONDARY MORTGAGE MARKET

A NOTE ON THE GLOBAL GROWTH OF THE MORTGAGE MARKET

ABOUT THE AUTHOR

Chapter 6: The Equity Market

INTRODUCTION

CASH MARKET—ORIGINS

EQUITY DERIVATIVES

DECLINING TRADING COSTS INCREASE FINANCIAL ENGINEERING OPPORTUNITIES, AND FINANCIAL ENGINEERING OFTEN REDUCES TRADING COSTS

ARBITRAGE COMPLEXES

EQUITY STRUCTURED PRODUCTS AND EXCHANGE-TRADED FUNDS (ETFS)

PORTFOLIO TRADING AND STOCK INDEX FUTURES CONTRACTS

SHAREHOLDER PROTECTION

TAX EFFICIENCY

THOUGHTS ON IMPROVING ETFS

ABOUT THE AUTHORS

Chapter 7: The Foreign Exchange Market

INTRODUCTION

HOW FOREX IS TRADED: THE INSTITUTIONAL FRAMEWORK

HOW ARE EXCHANGE RATES DETERMINED?

DERIVATIVES AND THE PRIVATIZATION OF FOREX RISK MANAGEMENT

ABOUT THE AUTHOR

Chapter 8: The Commodity Market

HISTORICAL PERSPECTIVE

EXCHANGE-TRADED VERSUS OTC COMMODITY PRODUCTS

FUTURES CONTRACTS

RISK MANAGEMENT WITH COMMODITY FUTURES/OPTIONS

COMMODITY SWAPS

COMMODITY OPTIONS

FINANCIAL ENGINEERING IN COMMODITIES MARKETS

COMMODITY ETFS

REGULATION OF COMMODITY MARKETS

A FINANCIAL ENGINEERING EXERCISE: SYNTHESIZING BARTER

ABOUT THE AUTHORS

Chapter 9: Credit Markets

INTRODUCTION

PREDECESSOR PRODUCTS

APPLICATIONS

FIRST-GENERATION PRODUCTS: 1992–2000

SECOND-GENERATION PRODUCTS: 2001–2007

GOING FORWARD

ABOUT THE AUTHOR

Part III: Key Applications of Financial Engineering

Chapter 10: Securitized Products

INTRODUCTION

ORIGINS OF SECURITIZATION

MARKET SIZE AND SEGMENTS

TRANSACTION PROCESS

CREDIT RATINGS

ABOUT THE AUTHOR

Chapter 11: Structured Products

INTRODUCTION

A HISTORY

EQUITIES

CREDIT

CONCLUSION

ABOUT THE AUTHOR

Chapter 12: Thoughts on Retooling Risk Management

INTRODUCTION

REVISITING THE TONE AT THE TOP OF THE ORGANIZATION

CONDUCT A BOARD-LEVEL REVIEW OF VAR AND STRESS TESTING

ADDING WARNING LABELS TO RISK REPORTS

CONCLUSION AND AN ENDNOTE

ABOUT THE AUTHORS

Chapter 13: Financial Engineering and Macroeconomic Innovation

INTRODUCTION

A REFRESHER ON MONETARY POLICY

POLICY TOOLS OF CENTRAL BANKS

THE FEDERAL RESERVE AND THE LIQUIDITY CRISIS

EXPRESSING A VIEW: INVESTING WITH PRICE INSTABILITY

MACROECONOMIC DERIVATIVES

ABOUT THE AUTHORS

Chapter 14: Independent Valuation for Financially-Engineered Products

INTRODUCTION

THE UNIVERSE OF FINANCIALLY ENGINEERED PRODUCTS

THE FAIR VALUE HIERARCHY

MODELING ALTERNATIVES: CDOS

INCORPORATING THE EFFECTS OF ILLIQUIDITY IN VALUATION

THE ROLE OF THIRD-PARTY VALUATION PROVIDERS

CONCLUSION

ABOUT THE AUTHORS

Chapter 15: Quantitative Trading in Equities

INTRODUCTION

STRUCTURE OF QUANTITATIVE EQUITY MODELS

OUTLOOK

ABOUT THE AUTHOR

Chapter 16: Systematic Trading in Foreign Exchange

INTRODUCTION

IS SYSTEMATIC TRADING JUST FOR GEEKS AND QUANTS?

WHAT CAN SYSTEMATIC TRADING ANALYSIS DO FOR ME?

ADVANTAGES AND LIMITATIONS OF SYSTEMATIC TRADING

WHAT IS NECESSARY FOR A SYSTEM TO WORK?

WHAT CAN I REASONABLY EXPECT?

USES OF SYSTEMATIC TRADING METHODS

EVALUATION OF SYSTEMATIC TRADING IDEAS AND PRODUCTS

ABOUT THE AUTHORS

Part IV: Case Studies in Financial Engineering: The Good, the Bad, and the Ugly

Chapter 17: Case Studies Introduction

INTRODUCTION

ABOUT THE AUTHOR

Chapter 18: Mortgage Case Studies: Countrywide and Northern Rock

CASE STUDY ONE: COUNTRYWIDE FINANCIAL1

CASE STUDY TWO: NORTHERN ROCK2

ABOUT THE AUTHOR

Chapter 19: Derivatives Case Studies: SocGen, Barings, and Allied Irish/Allfirst

CASE STUDY ONE: SOCIéTé GéNéRALE1

CASE STUDY TWO: BARINGS2

CASE STUDY THREE: ALLIED IRISH/ALLFIRST3

ABOUT THE AUTHOR

Chapter 20: Fixed Income Case Study, Swap Market: The Allstate Corporation

THE ALLSTATE CORPORATION1

ABOUT THE AUTHOR

Chapter 21: Lessons from Funds: LTCM, Florida, and Orange County

CASE STUDY ONE: LONG-TERM CAPITAL MANAGEMENT1

CASE STUDY TWO: FLORIDA STATE BOARD OF ADMINISTRATION2

CASE STUDY THREE: ORANGE COUNTY MARKET RISK EVENT3

ABOUT THE AUTHOR

Chapter 22: Credit Derivatives Case Studies: AIG and Merrill Lynch

CASE STUDY ONE: AMERICAN INTERNATIONAL GROUP (AIG)1

CASE STUDY TWO: MERRILL LYNCH2

ABOUT THE AUTHOR

Part V: Special Topics in Financial Engineering

Chapter 23: Performance Fees

INTRODUCTION

PERFORMANCE FEES

HEDGE FUND VERSUS MUTUAL FUND FEES

ABOUT THE AUTHOR

Chapter 24: Musings About Hedging

THE HEDGING ORIENTATION

THE TRADING ORIENTATION

THE ACCOUNTING ORIENTATION

CONCLUSION

ABOUT THE AUTHOR

Chapter 25: Operational Risk

INTRODUCTION AND CURRENT STATE OF KNOWLEDGE

A BRIEF HISTORY OF THE BUSINESS OF OPERATIONAL RISK

OVERVIEW OF SUBJECT

MORE ON HEDGE FUNDS AND OPERATIONAL RISK

MITIGATING OPERATIONAL RISK

ABOUT THE AUTHOR

Chapter 26: Legal Risk

INTRODUCTION

KEY LEGAL RISKS

MITIGATING LEGAL RISK

THE REGULATORY LANDSCAPE

REGULATORY EVOLUTION

ABOUT THE AUTHOR

Chapter 27: Portable Alpha

INTRODUCTION

WHAT IS PORTABLE ALPHA?

THE APPEAL OF PORTABLE ALPHA

ABOUT THE AUTHORS

Chapter 28: The No-Arbitrage Condition in Financial Engineering: Its Use and Misuse

INTRODUCTION

THE OPTIMIZATION FORMULATION

POSSIBLE SOLUTIONS

MARKET EQUILIBRIUM

THE DUAL PROBLEM

PRICING RELATIONSHIPS

PERFECT CAPITAL MARKETS

A TWO-STATE, SINGLE-PERIOD EXAMPLE

INCORPORATING THE EVENT OF DEFAULT

A MULTIPERIOD FRAMEWORK

INCORPORATING DEFAULT

CONCLUSION

ABOUT THE AUTHOR

Chapter 29: Influencing Financial Innovation: The Management of Systemic Risks and the Role of the Public Sector

INTRODUCTION

FINANCIAL MARKET INNOVATION

INCOMPLETE MARKETS FOR INSURANCE RISK

PUBLIC POLICY CONSIDERATIONS

CONCLUSION

ABOUT THE AUTHORS

Part VI: Appendices

Appendix A: IT Tools for Financial Asset Management and Engineering

INTRODUCTION

BASIC MS-EXCEL® TOOLS

MATHEMATICA®, GAUSS™, MAPLE®, AND MATLAB®2

BLOOMBERG®3, INFORMATION, AND THE API

MORE COMPLEX MS-EXCEL COMPUTATIONS

MONTE CARLO SIMULATION

CONCLUSION

READER RESOURCES

ABOUT THE AUTHOR

Appendix B: About the Companion Website

MORE ABOUT THE SURVEY

About the Editors

Index