Duration: 2 days
- Introduction to Financial Engineering
- Building Blocks of Financial Engineering
- Analyzing and Using Swap Curves
- Volatility Estimation
- Option Pricing Models
- Monte Carlo Simulation
- Constructing Structured Products
- Reverse Engineering and Risk Management
The objective of this seminar is to provide the participants with a state-of-art toolkit for
"Financial Engineering" and a good understanding of how these tools can be used to construct - or
to decompose - financial structures with the desired risk/return characteristics. We start with a
general introduction to "Financial Engineering" and discuss the purposes of using financial
engineering in modern finance. We then take a closer look at the "Building Blocks" of financial
engineering. We explain the "Generic Risks" (market risk, credit risk etc.) into which all
financial products can be decomposed, and we show how these generic risks can be put together into
products with almost any desired risk/return profile, using the "Chinese Menu Approach". We review
how swap curves can be constructed from available market data and how these curves are used for
pricing and risk analysis. We also briefly present the latest state-of-the-art techniques for
volatility estimation. Next, we present the tools of financial engineering and explain how these
can be used to construct the desired structured products. These tools include cash instruments,
swaps, forwards and options. We explain how these instruments can be analyzed and how the
risk/return characteristics can be summarized, providing the "Financial Engineer" with the
necessary tools to construct instruments in a very powerful and flexible way. The techniques are
illustrated by a number of worked examples, where we apply the toolkit to selected financial
problems, resulting in some basic structured products. Finally, we present a structured approach to
decomposing existing structures into basic building blocks that are easier to analyze for risk
management purposes.
Day One
09.00 - 09.15 Welcome and Introduction
09.15 - 12.00 Introduction to Financial Engineering
- What is "Financial Engineering"?
-
Purpose of Constructing Synthetic Instruments
- Yield enhancement, arbitrage/regulatory arbitrage etc.
- The "Chinese Menu" Approach
Building Blocks of Financial Engineering
-
Cash Instruments
- Cash and cash equivalents
- Money market instruments and bonds
- Stocks
- Forwards and Swaps
-
Options
- "Vanilla" and "exotics"
- Interest rate options
- Credit Derivatives
12.00 - 13.00 Lunch
13.00 - 16.30 Analyzing and Using Swap Curves
- The "Par" curve
- Accrual and Yield Conventions
-
Bootstrapping the Swap Curve
- Spot rates
- Discount factors
- Using FRAs, deposit futures and par swaps
- Convexity adjustment
-
Forward Rates
- Deriving forward rates from the spot curve
- Pricing FRAs and other forward contracts
-
Pricing Swaps
- Standard swaps
- Amortizing and accreting swaps
- Forward starting swaps
- Moving the spread from fixed to floating side
- Pricing currency swaps
- Examples and Exercises
Day Two
09.00 - 09.15 Recap
09.15 - 12.00 Option Pricing Models
- Models for Stock Options (B&S + CRR)
-
Models for Interest Rate Options
- Black
- BDT, Hull-White etc.
- Volatility Estimation and Forecasting Techniques
- Examples: Pricing Different Types of Options
- Exercises
Monte Carlo Simulation
- General Introduction to Monte Carlo Simulation
-
Monte Carlo Toolkit
- Generating random numbers
- Sampling techniques
- Stochastic differential equations
- Exercises
12.00 - 13.00 Lunch
13.00 - 16.30 Constructing Basic Structured Products
-
Defining the Required Risk/Return Profile
- In terms of generic risks
- In terms of "risk factors"
-
Constructing the Product
- Using the "Chinese Menu Approach"
- Examples of Basic Structured Products
- Exercises
Reverse Engineering and Risk Management
- Decomposing Instruments Into Basic Building Blocks
- Creating a "Delta Vector"
- Cash Flow Mapping and "Key Rate Duration"
- Using Principal Components Analysis to Factor Out Risks
- Calculating Aggregate Risk of Selected Positions
- Using PCA with Monte Carlo Simulation
Evaluation and Termination of the Seminar