Financial engineering uses quantitative analysis and methodologies in the creation of financial products and financial strategies. Although somewhat tainted by the financial meltdown of 2008, financial engineering provides businesses with advantages, including risk limitation, alternative methods of compensation and improved investment outcomes.
Financial engineering creates or packages financial instruments, such as stocks, bonds and securities, with the goal of addressing situation-specific risk and reward needs. The creation of instruments relies on a complex combination of financial modeling, data analysis and risk analysis. If, for example, you provide financial consultation services to businesses or are involved in banking, you would use these processes to assess or develop new financial instruments. For businesses not directly involved in the finance industry, financial engineering offers a means for developing financial strategies aimed at profit improvement or structuring the financial elements of contracts.
Certain kinds of contracts, particularly those involving future delivery of services or commodity futures, operate under heightened risk because of uncertainty. When a business chooses to invest in another business, such as a startup, the potential for failure increases the risk. Financial engineering can help businesses structure contracts in such a way that you face reduced risk through the use of contingent payments or forward contracts. Forward contracts, which specify a future date for payment, help manage problems with variable exchange rates when working with businesses abroad, such as a manufacturer that produces a critical part or product you require.
As businesses look for ways to engage high-performing management and retain key employees, some opt to provide stock in the business as an alternative to a strict money offer. This strategy can prove particularly useful during growth phases, as it improves the odds of higher stock performance. Financial engineering helps businesses understand the implications of giving stock in lieu of cash in terms of what it means for the balance sheet, as well as what it means for income statements. Some financial engineering firms also provide a tax assessment as part of their services.
Some businesses choose to invest excess capital in stocks or mutual funds as a means of making that capital work for them or to provide funding for retirement benefits. If the business manages its own portfolio, financial engineering can help it assess the total risk of its portfolio and devise strategies to minimize that risk. For example, your business might institute a set of put and call options that would allow you to buy or sell at critical thresholds.