Financial Engineering

[tr|n|ty]

Prior to the Asian Stock Market Crash, i was interning(this was 3 years ago) with the Research division of the Philippine Stock Exchange and we were doing a lot of studies on different Equity products to be offered to the Philippine Market. We worked closely with the Financial Engineering Division of Citibank. I was just wondering if anything has happened in offering options, futures and other derivatives to the market? I remember distinctly that we were looking at put and call warrants.

With that long intro, anybody out there who are interested in Financial Engineering? Creating new products to be traded in the markets and not just "plain vanilla" or standard derivatives...

Examples are Standard Oil's Bond Issue, ICON or the Index Currency Option Notes(developed by Bankers Trust) or Range Forward Contracts. there are also weather, electriciy, insurance and credit derivatives, among others

[Crusher]

Financial Engineering?
So is there a university or college offering this course now in the Philippines or just through seminars and classes in banks and financial institutions?
How does one qualify?
And how are the instruments you mentioned basically differ from one another? Aren't all of them some form of investments where a certain rate of interests are paid to the investors?

[tr|n|ty]

i wouldnt know if there's a course offering in the Philippines. I'm sure Columbia has one, so do Berkeley, Michigan among others

what is financial engineering?

Financial engineering is the process whereby a portfolio is designed and maintained in such a manner as to achieve specified goals. Financial institutions use financial engineering to create complex derivative instruments. That process may include the following steps:

- Designing a derivative instrument which will appeal to one or more of the institution's clients
- Developing a hedging strategy for the portfolio of assets or liabilities which will support that instrument
- Pricing the instrument based upon the anticipated cost of the hedging strategy
- Implementing the strategy once the instrument has been sold

Financial engineering is often thought to require a great deal of mathematical sophistication. Indeed, much of financial engineering depends on advanced mathematical modeling of financial markets. Many simpler tasks, however, such as duration matching a fixed income portfolio or delta hedging a foreign exchange option, require less mathematical sophistication—but represent financial engineering nonetheless.

[tr|n|ty]

first of, let's start with basic terms

derivatives-financial instruments whose value depends on the values of other, more basic underlying variables like foreign currency exchange rates, stocks, and even livestock or weather for that matter. Forwards, swaps and a variety of options are sold over the counter or by different financial institutions. Derivatives are also part of bond issues.

basic examples of derivatives:
1. Forward Contracts-it is an agreement to buy or sell an asset at a certain future time for a certain price
kinds:
long-allows you to buy
short-allows you to sell
2. Options are like forward contracts BUT it only gives you the right not the obligation to buy or sell a certain issue.
kinds:
put-you have the right to sell
call-you have the right to buy

[SUX2BU]

*binura kasi ang panget ng PEx eh* :D

[SUX2BU]

I know that some top foreign banks in the Philippines did some fast-tracking of some of their professionals who are interested in the design and development of their financial products, segments of currency, hedging and financial risk management et cetera. I was also interested before, but that was the time when I was planning on shifting careers, so no thank you. Financial engineering does not only apply and deal with advanced mathematical methods and financial theories, but it is also involved in the application of computer technologies to financial markets and management, actually a cross-disciplinary field on finance, economics, physics, mathematics, engineering, computational science and emerging technologies. It is a relatively budding profession, and is now being offered in the US and some parts of Asia (not sure about the Philippines, though) as a Masteral course. :)

[tr|n|ty]

yup, SUX2BU. A professor of mine in college helped develop certain decision-end financial software in relation to financial engineering. I'm sure basic options classes are available in universities in the Philippines but i'm not too sure about the Masteral program. I know NUS is offering it, that's somewhat in the geographical area. a friend of mine who has a degree in Industrial Engineering is currently taking her MS in Financial Engineering in Columbia. I'm interested since i'm a big math buff(yes, a certified geek over here :nerd: ).

SUX2BU, do you think the Philippines is ready for a wider variety of financial instruments?

[SUX2BU]

double post. leche. :lol:

[SUX2BU]

double post. leche. :lol:

[tr|n|ty]

triple post nga e.

[SUX2BU]

SUX2BU, do you think the Philippines is ready for a wider variety of financial instruments?

Aspects like foreign exchange, commodity, interest rates, weather (hey, there are instruments based on weather changes :D), credit, risk on capital market instruments et cetera should be factored in. With the economy as bad as the Philippine economy. Hmmm, i'm having doubts about that.

What do you think? :)

[SUX2BU]

By the way, own equity instruments, weather derivatives, financial guarantees, commodity contracts and intangible assets are not financial instruments. :)

[tr|n|ty]

i think there's a need to expand products offered in the market, you would be shocked with how many people are actually willing to get into investing because Filipinos are natural gamblers. as for non-financial instruments, i did mention a few like commodity contracts credit risk, weather and electricity in my first post...they are considered options and instruments for hedgers, speculators and abitrageurs.

[SUX2BU]

Yeah, there's a need, but with the slump in the Philippine economy and industries, who would gamble now? Just look at the way FOREX is moving. Let's just say that probabilities of a ubiquitously profitable new market products are nil across any Philippine industry right now.

[tr|n|ty]

well developing them right now should be a good endeavor..launching is another story.

[mac_bolan00]

Originally posted by tr|n|ty
SUX2BU, do you think the Philippines is ready for a wider variety of financial instruments?
if the question pertains to applicability of derivatives in the philippines, the answer is yes. it is indeed being applied here. if the question has more to do with the possibility if these intruments being traded by the public, than answer is no.

actually, financial engineering is simply an application of the principles of corporate finance and economics. the math aspect is not even close to that of the "physical" engineering courses. of course, those so-called rocket scientists try to apply calculus and other multi-variate methods but it's mainly to impress the vast majority of finance professionals who don't even know how to set up an algebraic equation.

when i was in the stock market, i used nothing more than moving averages and multiple regression for my time-series analysis.

:D

[tr|n|ty]

aww...harsh words.

but then again, looking back..i think a math degree with a econ minor would have been a great choice in college over my finance and econ.

but anyways, i digress.

mac_bolan00- so u don't think that derivatives are going to be publicly traded any time soon in the Philippines? why not?

[mac_bolan00]

trading by the investing public has very little to do with the underlying soundness of the instruments being offered. quite simply, the fin-trading business is a crap-shoot. the traditional sectors, T-bills, forex and equities is currently moribund. hardly any volume. should there be a run-up similar to that in 1993, people should at least be wary. but then... in my experience, the stock market has a very short memory. so we'll see a lot of people crying in the lounges, in the elevators and possibly jumping off the 30th floor should the market revitalize.

no, dirivatives shouldn't be traded publicly. they should be used for their original intended purpose: to hedge against risks.

p.s., i take it you view yourself a rocket scientist.

[zimdude]

sorry for my layman's question:
so how do banks, insurance companies, etc. keep their client's money intact, if not growing?

[aticus]

Originally posted by zimdude
sorry for my layman's question:
so how do banks, insurance companies, etc. keep their client's money intact, if not growing?

Layman's answer: They use that money to try to make more money. Some ways would include lending it to people at higher rates than their deposits (done by all banks) and/or investing in instruments that yield higher than the cost of "borrowing" the money in the first place.

Banks and other groups "borrow" money from the public by offering them rates of deposit. They actually "loan" your money when you deposit with them, and the interest they give you is the "loan interest." :)

Banks, by the way, are the ones most into financial engineering, as it is their business to make money with other people's money. They also have to use this model regardless of how good, or bad, the economy is at any given moment. This is why it is critical for them to do long-term financial planning.

[mac_bolan00]

trinity's story:

trinity makes chairs. one chair costs P 30 to make. With her P 120 and a P 10 mark-up per chair sold, she is able to make 4 chairs a year and profits P 40. well and good.

just one thing. she knows she can sell 8 chairs a year if only she had P 240. so she goes around looking for people who would lend (or give) her another P 120.

first stop, aticus. aticus is a venture capitalist. he has a sharp eye (being part-vulture) and knows a winner when he sees one. he offers to give trinity not P 120 but P 160. nice. what's the snag? aticus wants to end up owning the majority of pexchairs, inc. trinity leaves in a huff and gives aticus this kissoff: "you're the chubbiest vulture capitalist i've ever seen!"

next stop, kuya danny. KD is a money lender: absolutely no interest in owning pexchairs (or owning trinity for that matter). P 120? easy. payable in 12 months at 5% a month and with the following conditions:

1. trinity to either secure the loan with her P 240 flower pot (KD wants a 200% collateral coverage) or it could be a clean loan but...

2. trinity had to open an account with KD and maintain an average daily balance of P 40 pesos.

trinity runs the numbers and finds to her dismay that, given a lumpy sales pattern, credit sales and all of KD's conditions, her business won't be able to churn out cash to pay interest and principal on time. she walks out of KD's office coldly but makes a mental note to invite him to a cup of coffee one of these days.

next stop, mac_bolan00. mac is an investment banker. trinity approached him accidentally because she needed to go to the powder room and mac happened to look (and sometimes act) like a janitor. mac juggled the figures trinity gave him, looked at aticus' and KD's offices in disgust, spat in those directions and said: even if you had P 240 for your very own, i wouldn't advise you to try selling 8 chairs a year. your money will just get tied up in receivables. 6 chairs is about right. you'll keep your receivables low and your selling price won't have to go down. that means you need only an additional P 60. he starts pointing to possible alternatives:

1. mac could a form a loan sindicate composed of four money lenders. if they split the amount, they'll probably charge an average interest charge of only 1.1% a month, two months grace period on principal, and a monthly re-payment. collateral coverage had to be at least 100% with specific assignments to each syndicate member.

2. offer to float P 60 in new equity, whether privately or on the stock market. mac advised against the stock market knowing that market was already heavy on issues soon to crack in this current state of the economy. those issues included scented candles, soaps, internet and cell cards, fake osama beards, and CHAIRS.

so the prospect of a private placement looked good. no interest to pay, no principal repayment to worry about. trinity will not benefit when it comes to returns since the incremental earnings will become attributable to whoever puts up additional equity. but that didn't matter since she had no plans of increasing her take anyway. in fact, she wanted to reduce her own take and that of the prospective investors. the increase to 6 chairs will weaken her stongest competitor's position (delisyus recliners, inc.) all in all, trinity's business will end the year as the biggest chair-maker and with enough cash to target an 8-chair level the following year.

she turns around to thank mac_bolan00 but finds him gone. also, she discovers too late that mac filched P1.8 from her wallet (equal to 3% of the float amount) and that he had pulled trinity's back zipper more than halfway down.

[tr|n|ty]

Originally posted by mac_bolan00
p.s., i take it you view yourself a rocket scientist.

not exactly. i'm actually a very naive and dumb girl. i just like to use big words like financial engineering to make me sound smart. it's all a sham. :glee:

oh yah, interesting story.

so i take it you're one hell of a sanitation worker?

[KuyaDanny]

Bravo! :handsdown:

I sure hope tr|n|ty was wearing a brassiere. :lol:

[tr|n|ty]

hey hey..leave my lingerie habits alone!! :glee:

the presence or absence of the said undergarment is not an integral part of the case study. or is it? if i had not worn a brassiere, would it mean that i would have gotten better terms in my deal with KD?

he he he.

[aticus]

I've lost 39 pounds since June. I'm not so chubby anymore... :) That, and I may be more vulture than the story would indicate... ;) hehehe

:lol:

[Ithacxa]

Locally, I know of DLSU offering a Masters in Computational Finance course for people who have quantitative backgrounds. It takes about two years to finish. Check their website out.

Over in the US, a lot of top schools are offering their own variation. I also know that many of them can be finished in less than two years, although admittedly, the costs are much higher than those here in the Philippines.

UC Berkeley - Masters in Financial Engineering Course
Carnegie Mellon - Master of Science in Computational Finance
etc., etc.

[AteRonee]

Originally posted by tr|n|ty
the presence or absence of the said undergarment is not an integral part of the case study. or is it? if i had not worn a brassiere, would it mean that i would have gotten better terms in my deal with KD?

he he he.

But you know how the male brain thinks, considering that the case study author and his cast of financiers are all male. *poke*

Whether you could get better terms with KD will depend on the approval of the loan committee chaired by yours truly. :wink:

mac_bolan00, what a fun illustration for a case study! *okay*

[tr|n|ty]

the all-male financing team..tsk tsk. i think i would be better off showing some skin. hehehe. but then again, with all due respect to the chairman of the loan committee, will you allow some skin-bearing to further the growth of the economy? :p

[SUX2BU]

not exactly. i'm actually a very naive and dumb girl. i just like to use big words like financial engineering to make me sound smart. it's all a sham.

How disappointing! :eek:

[tr|n|ty]

he he he, SUX2BU.

you know me better than that. ;)

[mac_bolan00]

Originally posted by SUX2BU
How disappointing! :eek:

MODERATORS ALERT! ALERT!

sux2bu virus detected in the working filipino forum.

main features: no productive entries, un-imaginative snipes at other PEXers, cannot compose more than three (3) sentences per post.

[SUX2BU]

MODERATORS ALERT! ALERT!

mac_bolan00 virus detected in the working filipino forum.

main features: silly and stupid entries, silly and stupid snipes at other PEXers, can compose more than three (3) silly and stupid sentences per post.

[mac_bolan00]

new feature observed for the sux2bu virus:

lacks creativity.

[tr|n|ty]

boys, can we take this some where else?

:grrr:

[mac_bolan00]

pistols! tommorow at dawn!

:D

[SUX2BU]

new features observed for the mac_bolan00 virus:

sillier and stupider.

[SUX2BU]

Grass, sorry, but Mister Geezer follows me everywhere. Should I be flattered? Nah. ;)

[tr|n|ty]

Dennis, you are beyond flattery.

[mac_bolan00]

he's beyond reason.

but swerving back to the topic, financial engineering should be brought back to the basics. too many people retire form the "finance profession" with little knowledge gained other than basic financial analysis and marketing of standard financial instruments (ie, loans).

to successfully engineer a value-creating move via financing, one must be an all-around business expert of sorts. this is because financial engineering is too dependent on marketing and operational factors. a little creativity in the part of sales or operations will throw what little value the CFO has created out the window.

[tr|n|ty]

i think a lot of finance is marketing. ibankers that i meet and associate with will tell you that 80% of their job is marketing a possible M&A, IPOs, etc.

i think i agree with this Pexer i exchange PMs with that only few filipinos relate or are into finance. they would rather talk about IT or marketing. I personally think IT is a fad. lest we forget the sinking dot.coms. of course, IT will be part of our lives, to a certain extent. but as any finance person know, diversify diversify diversify.

sigh.

[tr|n|ty]

:glee:

[tr|n|ty]

Market That Deals in Risks Faces a Novel One (http://www.nytimes.com/2001/11/29/business/29SWAP.html)

When members of the International Swaps and Derivatives Association gathered in Washington last April, the man they all wanted to hear was Jeffrey K. Skilling, then the president and chief executive of Enron.

Enron had helped create the global market for energy-based derivatives — customized risk-swapping contracts that enable companies to hedge their exposure to changing energy prices and supply fluctuations. Even among traders more familiar with interest-rate swaps or currency hedges than energy contracts, Mr. Skilling's presentation did not disappoint.

[ibarramedia]

Originally posted by tr|n|ty
i think a lot of finance is marketing. ibankers that i meet and associate with will tell you that 80% of their job is marketing a possible M&A, IPOs, etc.

i think i agree with this Pexer i exchange PMs with that only few filipinos relate or are into finance. they would rather talk about IT or marketing. I personally think IT is a fad. lest we forget the sinking dot.coms. of course, IT will be part of our lives, to a certain extent. but as any finance person know, diversify diversify diversify.

sigh.

Yep diversify baby. Grass, my brother knows more about stocks and bonds. I would like to know more about finances. May take some classes in the future. My area pf expertise is more on criminal law and criminal justice. Interesting case studies nonetheles..

[SILENTMAX]

mac

sorry im an ignoramoose
i would like to know if the 200% collateral is seperate from the 40 pesos maintaining balance that mister kd is offering

is mister kd similar to most banks now?

and what are the alternatives for an sme to get loans from a bank? ive depleted my resources from angel investors and looking for banks, as an alternative to re-capitalizing. advisable?

thanks for any info
i am but a servant.....

[mac_bolan00]

yes, a bank can load a whole heap of conditions on your application. it's in the bank's interest to device a package that will be to the borrower's benefit. however (just don't report me to the BSP, the BAP and the CTB) the chief danger lies with 1) the lending officer who, too often, does not really go into the trouble of 'engineering' the package and 2) the credit committee who, though they may be smart, don't have all the information they need to make a correct decision.

there are ways for SME's to escape the collateral thing. one is to avail of a specially-funded loan (DBP, landbank, tidcorp, etc.) those groups give fund to banks which they will lend out to SMEs as long as they qualify. the banks will of course add a premium on interest but the funds were lent to the banks at very low rates. overall, it's still cheaper than a loan using bank funds (known as a 'bank carry' loan).

loan value of a collateral = fair market value x 0.8 x 0.6

the 0.8 is to play down FMV which is almost always overblown. the 0.6 is to compensate the bank for holding/processing costs (and the fact that the property will tie up their loanable funds once foreclosed).

the ADB requirement is not so much a security but more of additional services sold to the customer (deposit services in addition to lending). it's part of the current trend called 'cross-selling'.

back to the case, KD wasn't really playing it ultra-safe. he knew trinity won't be able to service the loan. he was after trinity's flower pot. ;)

[Kaiser88]

Originally posted by tr|n|ty
i think a lot of finance is marketing. ibankers that i meet and associate with will tell you that 80% of their job is marketing a possible M&A, IPOs, etc.


exactly! in IB, the goal is to sell sell sell. everyone knows the numbers in any deal can be concocted in a hundred different ways. at the end of the day, what ibankers really care about is the amount of fees they're getting.

[mac_bolan00]

i can speak only for lending, here in the philippines. however, since lending is the gist to IB, i can qualify it as well. the marketing aspect is a bit overblown. the whole financial business is more efficient than, say, the consumer products sector. IT'S SO EASY TO SELL A LOAN. if you notice, banks hardly ever advertise their lending services (except those for consumer lending). it's their deposit and trust services that are hard to market. companies approach banks for loans, get it?

because of this, the finance man's most important skill anchor is still FINANCIAL ENGINEERING.

[Kaiser88]

Originally posted by mac_bolan00
i can speak only for lending, here in the philippines. however, since lending is the gist to IB, i can qualify it as well. the marketing aspect is a bit overblown. the whole financial business is more efficient than, say, the consumer products sector. IT'S SO EASY TO SELL A LOAN. if you notice, banks hardly ever advertise their lending services (except those for consumer lending). it's their deposit and trust services that are hard to market. companies approach banks for loans, get it?

because of this, the finance man's most important skill anchor is still FINANCIAL ENGINEERING.

mac_bolan00,
i beg to disagree, lending is not the gist of investment banking. i-banks help companies raise money through IPOs, share placements, bonds, and the like. yes, the finance person's most important skill is a solid knowledge of financial engineering. however, for investment bankers, it is a requirement that they be able to aggressively sell their product whether it be selling a stock, selling a company, or selling an idea. Selling a deal is what i-banking is all about.

[mac_bolan00]

investment banking where? here or abroad? here in the philippines, all an investment bank/bank has to do is ride piggyback on a loan syndication and he's in, with nary a step of marketing effort.

there is hardly any difference between a bank account officer's job and an investment banker's. the IB role is just expanded a bit to include funding through equity and other non- bank-carry loans. AOs and IBs work like dogs to do the market and industry risk study, design the package, set terms and conditions, comply with BSP and other gov't regulations. they give financial advise, reingineering considerations, arrange for M&As. it's all practically the same. again, the wholesale nature if the transaction minimizes one's marketing effort. the borrower will come to you.

in our bank, there are at least 30 account officers, each with at least 30 corporate accounts. all those accounts keep applying for higher ceilings and we keep evaluating new accounts applications.

[SILENTMAX]

our character loans still being given in banks in the philpphines
which banks?
how long do u have to be a depositor or customer in a bank to be eligible for one?

[Kaiser88]

Originally posted by mac_bolan00
investment banking where? here or abroad? here in the philippines, all an investment bank/bank has to do is ride piggyback on a loan syndication and he's in, with nary a step of marketing effort.

there is hardly any difference between a bank account officer's job and an investment banker's. the IB role is just expanded a bit to include funding through equity and other non- bank-carry loans. AOs and IBs work like dogs to do the market and industry risk study, design the package, set terms and conditions, comply with BSP and other gov't regulations. they give financial advise, reingineering considerations, arrange for M&As. it's all practically the same. again, the wholesale nature if the transaction minimizes one's marketing effort. the borrower will come to you.

in our bank, there are at least 30 account officers, each with at least 30 corporate accounts. all those accounts keep applying for higher ceilings and we keep evaluating new accounts applications.

ok now i see the source of the confusion, you're talking about local investment banks. i was referring more to foreign investment banks.
the investment bank i work for is based in the Philippines but has offices worldwide. our clients are Philippine corporations who need funds but can't raise them locally. therefore, these companies look to the capital markets in order to find foreign investors (and funds) who are willing to infuse money into their company. here's where the investment bank comes in - the bank's job is to evaluate the company and sell it to interested foreign investors who have the cash. it's a bit simplified but that's basically it.

[Ramirez]

I think DLSU has a MS Financial Engineering program.

[roadrage23]

Originally posted by Kaiser88
exactly! in IB,...what ibankers really care about is the amount of fees they're getting.
Kaiser88: I'm just curious. In your view, have overall IB fees for Philippine deals gone down from, say, two or three years ago? But I would understand if you wouldn't want to comment. Cheers. :)

[Kaiser88]

Originally posted by roadrage23

Kaiser88: I'm just curious. In your view, have overall IB fees for Philippine deals gone down from, say, two or three years ago? But I would understand if you wouldn't want to comment. Cheers. :)

roadrage23,
i can't speak for our competitors but at our firm, yes, fees have definitely gone down in the last two years. We've had a tough time closing deals since investors have lost interest in the Philippines.

[roadrage23]

Originally posted by Kaiser88
roadrage23,
i can't speak for our competitors but at our firm, yes, fees have definitely gone down in the last two years. We've had a tough time closing deals since investors have lost interest in the Philippines.
Kaiser88: How true. The Philippines is still outside a lot of investors' radar screens. :rolleyes:

[mac_bolan00]

but there are still a lot of good companies here and banks just keep raking earnings from lending. there's a scale problem for foreign investments here.