What is Financial Engineering?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 08 October 2019
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Financial engineering is a process that uses existing financial instruments to create a new and enhanced product of some type. Just about any combination of financial instruments and products can be used. The process may involve a simple union between two products, or make use of several different products to create a new product that provides benefits that none of the other instruments could manage on their own.

One excellent example of financial engineering is financial reinsurance. Companies that offer reinsurance options essentially provide a way for the ceding insurer to minimize a drain on available resources when a major shift in premium growth or reduction is taking place. In this scenario, the process helps to create a stable environment that will allow the insurer to remain solvent and stable even when extreme conditions exist.

For the consumer, the work of a financial engineer to create new product offerings can be a great advantage. In some instances, the new and improved product is simply a repackage of several independent but complimentary products made available at a lower price. For example, the consumer may find that purchasing insurance coverage that provides dental, hospital, and prescription coverage may be significantly less expensive than purchasing individual plans.


Financial engineering works in other environments as well. The financial theory of offering several existing products under one package has become very common in the telecommunications industry, and many providers today offer bundled service packages that include local phone service, unlimited national long distance, Internet service, and cable or digital satellite television. The end result of this type of arrangement means one lower price to obtain three or more services at significant cost savings to the consumer.

Sometimes known as computational finance, this process relies heavily on mathematically calculating the outcome if various combinations of financial instruments are offered under one umbrella as a package deal. Usually, the calculations indicate that the providers stand to do very well with the new hybrid financial product, as the product holds the potential to attract new consumers who would have foregone use of one or more of the instruments if the only option was to purchase them individually.


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Post 6

Yes, financial engineering is a part of economics. Financial engineers are continuously working to crunch out less risky, more profitable financial instruments. One example of financial engineering being intertwined with the economy has to do with the mortgage-backed securities that were traded in record high numbers prior to the 2008 crisis.

Bankers were able to take large numbers of warehoused mortgages off their books by pooling the mortgages together, dividing them up into individual securities with small fractions of many mortgages in each one, and selling the contractual rights to that income as a derivative. This is a problem when ratings agencies are stamping these as investment grade securities when they're really junk.

Also, swaps are a clever instrument devised

by financial engineers. They can range from simple to complex, and there are many variations of the "swap". I won't get into all of them, but they also played an important role in the financial collapse of '08. Since so many of these financial instruments are traded at enormous volumes on a daily basis, most of which were created by bankers (who call themselves financial engineers), I would have to make the argument that financial engineering is involved in economics. The argument could be made that our economy is actually predicated upon such financial instruments.

And for the other guy, an MBA would be more prudent than the mathematical finance degree. Furthermore, mathematical finance and financial engineering aren't the same thing. One is a legitimate discipline, and the other is a phantom discipline, respectively.

Post 5

Is financial engineering a part of economics?

Post 4

Remember, an MBA and a masters in finance are not the same thing. A MFin is purely finance, and extremely quantitative. If you want to be a financial engineer, typically MFin is the way to go. If you want to be a financial engineer, an MBA is not the most direct route.

Post 3

Bhutan - I agree with you that Harvard and Wharton offer the best financial engineering programs out there.

I understand that many companies are trying to trim their bottom line in order to become more profitable.

Some companies are offering smaller packages with fewer ounces in order to cut cost. The customer thinks they have the same perceived value because the packaging is the same.

This is happening a lot with cereals and other consumer products.

Many companies are offering less in terms of contents in order to save money. The packaging is the same and most people will not notice the difference.

Post 2

Anon154014 – That is fantastic. I think that Wharton School of Business and Harvard Business school are among the most prestigious MBA programs in the United States. People that graduate from these schools have the best earning potential and possibilities for obtainin the best financial engineering jobs.

I think more companies will be looking to hire MBA’s in order to shore up their bottom line in tough economic times.

Strategic financial planning is probably the key to continued profitability in most companies. Deciding whether to lay off employees and hire off shore employees is becoming more common these days.

Post 1

I am looking to do financial engineering and management (MBA). What are the good schools that I can apply to in the United States.

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