What Different Industries Use Financial Engineering?

D. Nelson
D. Nelson
Man with hands on his hips
Man with hands on his hips

Financial engineering is the practice of developing new strategies for investment. Professionals who practice financial engineering may use principles from mathematical disciplines, such as probability, computer engineering, and finance theory to create new instruments with more complex features or new investment packages that can offer investors unique options. To some degree, this financial practice can be found in nearly every kind of industry. It is most common, however, in the banking industry as well as in the manufacturing industry.

A common goal of all financial institutions, such as banks, is to gather money from clients to invest in a variety of financial instruments. Banks benefit most when they use investment strategies that allow them the highest returns with the lowest degree of risk. Financial engineering is used often in this industry because bank managers normally are interested in analyzing and possibly implementing strategies that increase their business's overall value.

In the manufacturing industry, a company depends on the value of its assets. Intangible assets, such as investments, can greatly impact a company's financial status in terms of credit and worth. Manufacturing companies with greater capital asset worth often find it easier to receive lines of credit. A line of credit provides cash flow that allows them to purchase equipment and hire labor to produce their goods.

Corporations that provide services for clients also use financial engineering. Consultant firms and retailers often invest to increase the worth of their operations. As in manufacturing, service industry corporations also depend on cash flow to operate. When a manager or executive increases the worth of his or her organization, he or she has more access to capital.

As a general rule, organizations with complex investment strategies can employ the help of financial engineering professionals. Smaller businesses with limited investment interests normally cannot benefit from these techniques unless they plan on drastically changing financial strategies. Companies that have budgets for high overhead costs can employ in-house financial engineers. These are professionals who focus solely on developing new strategies for a particular organization by using innovate mathematical disciplines, such as calculus and probability.

Companies that are interested in learning about how they can benefit from financial engineering strategies without the budget to hire full time analysts often hire consultants or advisers. These professionals normally analyze a company's portfolio and introduce managers to new financial products. If performed correctly, financial engineering can provide financial managers with new perspectives on investing that ensure financial stability while increasing returns on investments.

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Discussion Comments

hamje32

@Charred - I wonder how well the financial engineering used by manufacturing companies does to improve their credit position.

The reason I ask is not that I doubt the value of the investments, but because I have a general concern about the trend of the manufacturing industry.

If a bank looks at a manufacturing company with a shrinking bottom line but an increasing value because of investments it has made, does the bank extend the line of credit? I don’t know, I would kind of doubt it.

Charred

@MrMoody - I blame the whole financial engineering derivatives market on the financial gurus and their software.

Only software can figure stuff like futures out, in the quantity that it does. There’s no way that I could do it.

I agree with you, however, that software is no magic bullet. It doesn’t take into account the human variable. Investors can be a skittish bunch, operating in greed one moment and fear the next, creating huge swings in the market.

The only engineering model that I think is worth its salt in investing is “diversify” – otherwise known as Don’t Put all Your Eggs in One Basket, Version 1.0.

MrMoody

Engineering is the perfect specialty in my opinion for creating new financial instruments. I am still waiting for the ultimate mathematical algorithm that will ensure the highest rate of returns on my stock market investments.

I haven’t found it yet, although here and there I see financial engineering programs advertised which claim to use the perfect models to pick winning stocks, time and time again.

The only problem with computer models is that they can’t take into account variables that don’t exist, like a sudden spike in oil prices, or the Federal Reserve issuing negative statements about the state of the economy, or a default in a foreign nation’s loans.

Computers can only look at graphs and crunch numbers, so I guess that I’d have to take all such claims with a grain of salt.

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