Financial engineering as a discrete profession has evolved very quickly. In the late 1980s, ad hoc groups of traders, investment bankers, attorneys, quantitative research analysts, accounting, and operations professionals worked together periodically to produce new financial structures or solve specific corporate financing problems. It soon became evident that derivative-based financial problem solving for corporations produced a variety of capital market, trading, investment banking, and risk management opportunities. By the mid-1990s, firms engaged in the creation of structured derivative products recognized the need to properly support such activities and fused trading, investment banking, legal, research, accounting, and computer professionals into new departments described, for example, as global derivatives, structured products, equity derivatives, or fixed-income derivative groups. As with the types of financial products being developed, the financial engineering profession is evolving as investor needs are identified and matched with professional skills.
The creation and development of structured derivative products involves simultaneous steps that financial engineers (i.e., those who engage in designing and producing new derivative-based investment products) must take in bringing new products to market. Many investment opportunities involve fast-moving markets that can render potential transactions uneconomical in a very short time. Investor perceptions of and interest in potential investment opportunities are highly transient and can evaporate with almost any movement in the underlying market, such as price volatility, interest rate changes, or exchange rate moves. An active or static market can have varied meanings to different groups of investors. Therefore, success in launching structured product transactions is a function of preparation and timing.
Many structured product transactions are unique and, as a result of various legal, regulatory, marketing, and new product development issues and costs, often generate many questions and concerns among managers in charge of derivative trading and structured product groups. Such products often require modification of established administrative or operational procedures. As agents of change within an organization, structured products are often perceived as disruptive to established marketing, syndication, legal and compliance procedures, computer systems capabilities, and back office protocols. Therefore, it is usually necessary to properly address internal concerns in order for a financial engineer to advance his or her business goals.
Within investment banking and securities brokerage firms, like almost all organizations, there are those who run established business franchises and control many aspects of the everyday flow of business. Structuring new financial products represents a relatively new line of business within many financial firms and can be disruptive to routine business procedures. Financial engineers must compete for finite resources, such as management attention, access to capital, distribution channels, syndicate, technical, and research support. To be successful in an area of finance new to many people, financial engineers must constantly build and maintain internal organizational support and an infrastructure of managers, peers, and technicians who understand structured products, who share in the successes of such products, and who are willing to help advance structured product transactions.
The structured product offering process requires an integrated approach to organizational consensus building, process coordination, technical skill, and marketing insight. As mentioned, the financial engineer must communicate effectively in a nontechnical way with a varied constituency (e.g., senior managers, traders, investors, sales personnel, regulators, attorneys, middle managers, etc.). He or she must engage in a new product creation and development process that includes:
Topics 14 are discussed in this chapter. Topic 5 is discussed in Chapter 4.
Less than 10 years ago, ad hoc groups of traders, investment bankers, attorneys, and other professionals came together periodically to solve specific financial problems involving a loose conglomeration of instruments and strategies referred to collectively as derivatives. As new types of transactions occurred, evidence emerged from early successes and failures that a great deal of opportunity lay in a new and highly profitable area of finance now referred to by industry professionals as financial engineering. As a profession, financial engineering appears to be solidifying. New product development processes are being created, the identification and cultivation of investor demand are being refined, legal and regulatory issues are being clarified, and pre- and postoffering marketing skills are being perfected. Chapter 4 provides a summary of the constituent concepts of pricing, valuing, trading, and hedging new structured financial instruments.
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