Financial Engineering

Study level

Bachelor final year

Study load

30 EC

Provisional starting date

2 September 2013

Prerequisites

Elementary first year academic knowledge of mathematics, calculus, especially knowledge of probability.

Instruction language

English

English language requirement

IELTS 6.0 or TOEFL iBT 80

Tuition fees

To be paid at home institution

ABOUT THE PROGRAMME

Financial Engineering has developed from a niche area focusing on the pricing and hedging of structured financial products, to a broad discipline that addresses valuation and financial risk management in the entire financial sector. The modern financial markets, in which stocks, derivatives, insurance products, and more exotic contracts are traded in ever-increasing numbers, has been a powerful motivation for the development of advanced mathematical frameworks for pricing and trading strategies. The on-going financial crisis, on the other hand, has boosted the developments in global regulation and risk management, with an increasing influence on the core business of the financial industry. One of the major challenges in the field is to combine both perspectives, that of trading and risk management, in developing suitable financial services to all users, including households, companies and governments.

The first part of the programme is devoted to an introduction of elementary topics in corporate finance and investment theory. A course on statistics and probability updates required background knowledge. The second part further zooms in on insurance mathematics, derivatives, and risk management. In a final group assignment, you will be challenged to apply concepts, and to explore new directions in theory and practice.

LEARNING GOALS

COURSE INFORMATION - FIRST HALF OF SEMESTER

Introduction to Investment Theory – 5 EC

In this course, a broad overview is given of modern investment theory and the main mathematical tools that are used in that theory. Both deterministic cash flows and single-period stochastic cash flows are treated. Particular emphasis is put on the fundamental concepts underlying the financial theory, such as net present value, portfolio optimisation, risk aversion and arbitrage pricing models. Keywords include: discounting, present value theory, term structure of interest rates and yield curves, Markowitz portfolio theory, capital asset pricing, utility functions and positive state pricing.

Corporate Finance – 5 EC

In this course, we introduce the main principles of corporate finance. We explain some principles behind the valuation of financial assets and firms, leading to several formulas in terms of Net Present Value. Then we work towards the standard Modigliani and Miller theory of corporate finance, and some of its variants that account for tax effects and bankruptcy costs. From that perspective, we address the main issues in corporate finance: optimal dividend policy, optimal capital structure, other financial ratio analysis, and mergers and acquisitions. As a further motivation behind this, we also discuss goal congruence in financial statements, and the affordable growth concept. Theories are compared to financial data from several companies.

Statistics and Probability - 5 EC

Whether consciously or not, we come across statistics in our everyday life. From an opinion poll to a forecast of stock market behaviour in the future to a comparison of performances of different investment funds. For example, you may read in a newspaper that the "estimated yield of a certain portfolio for the next year is 6%". How should you interpret this? After all, the observations from the past do not guarantee the performance in the future! Also, what does it mean to say that an investment fund significantly outperforms another? Answers to these questions lie in better understanding the techniques used in Statistics to draw conclusions. Since we are going to deal with chance related phenomena, we start with the basic concepts of Probability theory. We will learn some basic probability distributions such as Binomial, Poisson, Normal, and Exponential. This will enable you to model many simple random variables encountered in practice by looking at their properties and comparing them with the theoretical ones, using e.g. the moment generating function and the central limit theorem. The course will conclude with different forms of inferential statistics such as maximum likelihood estimation, confidence interval and statistical hypothesis testing related to the parameters of simple models commonly encountered in practice. In the process, you will also learn to develop your own inference procedures if the standard ones from the book does not work exactly.

COURSE INFORMATION - SECOND HALF OF SEMESTER

Introduction to Risk Theory – 5 EC

We start with the so-called utility theory to answer questions such as why or when would one buy an insurance? Or from the insurance company's perspective: under what conditions they should start the business? While fixing the premium for an insurance, one of the important factors is the pattern of the risk at hand. In this course you will get a taste of the commonly used probabilistic models of risks, namely, individual model and collective model. You will also learn the principles commonly used in practice to fix a premium. During this process, the so called ‘ruin probability’ turns out to be an important factor. Two other topics treated in this course are credibility theory and IBNR (Incurred But Not Reported) techniques. Both of these topics deal with proper usage of available data from the past, and using them appropriately to make credible future estimations.

Financial Engineering and Risk Management – 5 EC

In this course, a theoretical basis is provided for the mathematical modelling of financial products. Emphasis is laid on discrete time stochastic models, both single-period and multi-period. Subjects include: multifactor analysis and regression for financial models; modelling of asset dynamics, basic pricing theory for futures and options, interest rate derivatives; binomial trees for European and American options, leading to the continuous-time Black-Scholes model. Furthermore, the course will provide students with a thorough understanding of the quantitative tools used to manage market risk (the risk of adverse price movements on assets), and credit risk (the risk of default of a debtor), and of Asset & Liability Management. The course will prepare students to manage risk in a quantitatively oriented fashion in both financial and non-financial corporations.

Practical Assignment Financial Engineering – 5 EC

In this course, students work on a realistic and relevant problem in quantitative finance. Not only financial theory but also practical knowledge, implementation, and communication issues play an important part. Supervised by a tutor with whom they discuss their intermediate results on a regular basis, a group of students will work together on the problem. When determining the final grade for the project, not only the quality of the final proposal is taken into account: the report, the cooperation within the group, and the justification of the result all play an important role as well.