financial engineering

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How I Became a Quant: Insights From 25 of Wall Street's Elite by Richard R. Lindsey, Barry Schachter

Albert Einstein, algorithmic trading, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, asset allocation, asset-backed security, backtesting, bank run, banking crisis, Bear Stearns, Black-Scholes formula, Bob Litterman, Bonfire of the Vanities, book value, Bretton Woods, Brownian motion, business cycle, business process, butter production in bangladesh, buy and hold, buy low sell high, capital asset pricing model, centre right, collateralized debt obligation, commoditize, computerized markets, corporate governance, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency risk, discounted cash flows, disintermediation, diversification, Donald Knuth, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, fixed income, full employment, George Akerlof, global macro, Gordon Gekko, hiring and firing, implied volatility, index fund, interest rate derivative, interest rate swap, Ivan Sutherland, John Bogle, John von Neumann, junk bonds, linear programming, Loma Prieta earthquake, Long Term Capital Management, machine readable, margin call, market friction, market microstructure, martingale, merger arbitrage, Michael Milken, Myron Scholes, Nick Leeson, P = NP, pattern recognition, Paul Samuelson, pensions crisis, performance metric, prediction markets, profit maximization, proprietary trading, purchasing power parity, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Reminiscences of a Stock Operator, Richard Feynman, Richard Stallman, risk free rate, risk-adjusted returns, risk/return, seminal paper, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, sorting algorithm, statistical arbitrage, statistical model, stem cell, Steven Levy, stochastic process, subscription business, systematic trading, technology bubble, The Great Moderation, the scientific method, too big to fail, trade route, transaction costs, transfer pricing, value at risk, volatility smile, Wiener process, yield curve, young professional

JWPR007-Lindsey April 30, 2007 16:14 328 JWPR007-Lindsey April 30, 2007 16:23 Chapter 24 John F. ( Jack) Marshall Senior Principal of Marshall, Tucker & Associates, LLC, and Vice Chairman of the International Securities Exchange W ithin the financial engineering community, I am perhaps best known to many as the person who gave definition to the field. My effort to define financial engineering began when I undertook the challenge of writing a book, with Vipul Bansal, titled Financial Engineering. (The publisher, a division of Simon & Schuster, later added the rather arrogant subtitle A Complete Guide to Financial Innovation.) We began this book in 1988 in response to our realization that finance, as we knew it and as we had been teaching it, was undergoing profound and fundamental change.

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The first step in the writing process was to interview people we considered financial engineers. I recall so many interviews that began 329 JWPR007-Lindsey 330 April 30, 2007 16:23 h ow i b e cam e a quant with the interviewee asking, “Financial what?” That book effort gradually led us to recognize that there was a need for a professional society to “foster the emerging profession of financial engineering.” This, in turn, led me, in 1991, along with Vipul and Robert J. Schwartz, to organize the International Association of Financial Engineers, Inc. (IAFE). We officially launched the organization on January 1, 1992, with 40 founding members, many of whom were the people we interviewed in the writing process.

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They later agreed to volunteer their time to serve as the editor and coeditor of the IAFE’s journal, the Journal of Financial Engineering. This journal served as the flagship publication of the IAFE until it was merged with the Journal of Derivatives. In the early 1990s, the IAFE undertook to develop a model curriculum for degree programs in financial engineering. I tried for two years to persuade the finance faculty at my university that this really was a new discipline and there was a need for degree programs in it. With the encouragement of a sympathetic dean, I spent the next year fleshing out a detailed curriculum and course syllabi for an MS degree program in financial engineering. Unfortunately, I could never win over a sufficient number of the faculty to get the program approved.

The Quants by Scott Patterson

Alan Greenspan, Albert Einstein, AOL-Time Warner, asset allocation, automated trading system, Bear Stearns, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, Black Monday: stock market crash in 1987, Black Swan, Black-Scholes formula, Blythe Masters, Bonfire of the Vanities, book value, Brownian motion, buttonwood tree, buy and hold, buy low sell high, capital asset pricing model, Carl Icahn, centralized clearinghouse, Claude Shannon: information theory, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Doomsday Clock, Dr. Strangelove, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial engineering, Financial Modelers Manifesto, fixed income, Glass-Steagall Act, global macro, Gordon Gekko, greed is good, Haight Ashbury, I will remember that I didn’t make the world, and it doesn’t satisfy my equations, index fund, invention of the telegraph, invisible hand, Isaac Newton, Jim Simons, job automation, John Meriwether, John Nash: game theory, junk bonds, Kickstarter, law of one price, Long Term Capital Management, Louis Bachelier, low interest rates, mandelbrot fractal, margin call, Mark Spitznagel, merger arbitrage, Michael Milken, military-industrial complex, money market fund, Myron Scholes, NetJets, new economy, offshore financial centre, old-boy network, Paul Lévy, Paul Samuelson, Ponzi scheme, proprietary trading, quantitative hedge fund, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, risk-adjusted returns, Robert Mercer, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Savings and loan crisis, Sergey Aleynikov, short selling, short squeeze, South Sea Bubble, speech recognition, statistical arbitrage, The Chicago School, The Great Moderation, The Predators' Ball, too big to fail, transaction costs, value at risk, volatility smile, yield curve, éminence grise

Rothman had described the quant meltdown as something models predicted would happen once in ten thousand years—but it had taken place every day for several days in a row. To Taleb, that meant something was wrong with the models. “These so-called financial engineers experience events that can only happen once, in the history of mankind, according to the laws of probability, every few years,” he told the room (full, of course, of financial engineers). “Something is wrong with this picture. Do you see my point?” Another slide showed a giant man sitting on the right side of a scale, tipping it heavily, while a group of tiny people scatter and fall on the left side.

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Worse, they believed their models were perfect reflections of how the market works. To them, their models were the Truth. Such blind faith, he warned, was extremely dangerous. In 2003, after leaving Oxford, he launched the CQF program, which trained financial engineers in cities from London to New York to Beijing. He’d grown almost panicky about the dangers he saw percolating inside the banking system as head-in-the-clouds financial engineers unleashed trillions of complex derivatives into the system like a time-release poison. With the new CQF program, he hoped to challenge the old guard and train a new cadre of quants who actually understood the way financial markets worked—or, at the very least, understood what was and wasn’t possible when trying to predict the real market using mathematical formulas.

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The world had little idea how close the financial system had come to a catastrophic seizure. The critical factor behind the crash of Black Monday on October 19, 1987, can be traced to a restless finance professor’s sleepless night more than a decade earlier. The result of that night would be a feat of financial engineering called portfolio insurance. Based on the Black-Scholes formula, portfolio insurance would scramble the inner workings of the stock market and set the stage for the single largest one-day market collapse in history. On the evening of September 11, 1976, Hayne Leland, a thirty-five-year-old professor at the University of California at Berkeley, was having trouble sleeping.

My Life as a Quant: Reflections on Physics and Finance by Emanuel Derman

Bear Stearns, Berlin Wall, bioinformatics, Black-Scholes formula, book value, Brownian motion, buy and hold, capital asset pricing model, Claude Shannon: information theory, Dennis Ritchie, Donald Knuth, Emanuel Derman, financial engineering, fixed income, Gödel, Escher, Bach, haute couture, hiring and firing, implied volatility, interest rate derivative, Jeff Bezos, John Meriwether, John von Neumann, Ken Thompson, law of one price, linked data, Long Term Capital Management, moral hazard, Murray Gell-Mann, Myron Scholes, PalmPilot, Paul Samuelson, pre–internet, proprietary trading, publish or perish, quantitative trading / quantitative finance, Sharpe ratio, statistical arbitrage, statistical model, Stephen Hawking, Steve Jobs, stochastic volatility, technology bubble, the new new thing, transaction costs, volatility smile, Y2K, yield curve, zero-coupon bond, zero-sum game

Quants and their cohorts practice "financial engineering"-an awkward neologism coined to describe the jumble of activities that would better be termed quantitative finance. The subject is an interdisciplinary mix of physics-inspired models, mathematical techniques, and computer science, all aimed at the valuation of financial securities. The best quantitative finance brings real insight into the relation between value and uncertainty, and it approaches the quality of real science; the worst is a pseudoscientific hodgepodge of complex mathematics used with obscure justification. Until recently, financial engineering wasn't really a subject at allwhen I entered the field in 1985, it didn't have a name and was something one learned on the job at an investment bank.

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"Stories can be wrong, but I'm uncomfortable trading without one... Looking only or primarily at their profit and loss statements is a recipe for disaster " He wanted to reward intelligence and long-term thinking rather than the short-term vagaries of markets. In his speech on being named the Financial Engineer of the Year by the International Association of Financial Engineers (IAFE) in 1994, Fischer said that he had always preferred applied research to academic. University professors, he claimed, should be paid and hired for their teaching, not their research; he believed that their desire to teach well would then lead them to do good research.

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Soon Risk was organizing expensive courses on exotic options, a clever arbitrage by which they charged quants from one set of investment banks to listen to the lectures of quants from another set, while Risk pocketed the fee. Other journals sprang up, too. The International Association of Financial Engineers, a new professional organization of quants, began to specify an educational syllabus suitable for the training of a quant. New textbooks and Master's of Financial Engineering programs sprouted and flourished at the increasing numbers of universities that, sensing a need, began to cater to those willing to pay to learn quantitative finance. In 1985 when I entered Will Street it was amateur heaven, a fluidly makeshift field filled with retreads from other disciplines who could learn quickly, solve equations, and write their own programs.

Capital Ideas Evolving by Peter L. Bernstein

Albert Einstein, algorithmic trading, Andrei Shleifer, asset allocation, behavioural economics, Black Monday: stock market crash in 1987, Bob Litterman, book value, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, computerized trading, creative destruction, currency risk, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, diversification, diversified portfolio, endowment effect, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, fixed income, high net worth, hiring and firing, index fund, invisible hand, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, market bubble, mental accounting, money market fund, Myron Scholes, paper trading, passive investing, Paul Samuelson, Performance of Mutual Funds in the Period, price anchoring, price stability, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, seminal paper, Sharpe ratio, short selling, short squeeze, Silicon Valley, South Sea Bubble, statistical model, survivorship bias, systematic trading, tail risk, technology bubble, The Wealth of Nations by Adam Smith, transaction costs, yield curve, Yogi Berra, zero-sum game

Retirement Economics is nothing new for Sharpe. In 1998, he was cofounder of Financial Engines, a successful Silicon Valley business venture to help individuals make the kinds of choices they confront as potential retirees—especially asset allocation and strategies to manage the risks they face. Financial Engines uses a computerized program, based on Sharpe’s contributions to portfolio theory and asset pricing. The output provides individuals with the same kind of sophisticated advice long available to institutional investors, high-ranking corporate officers, and wealthy people. Financial Engines is available, for example, at E*Trade, and for Vanguard investors with Admiral accounts, but many corporations and financial advisers also provide it for the benefit of their employees.

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Deeply rooted in Capital Ideas, outcome-investing is just plain English for what institutional investors describe as mean/variance analysis—a mathematical system for finding the highest expected return for any given level of risk exposure. Unlike widely advertised programs of financial advisers and brokerage houses, Financial Engines does not provide a definitive answer as to whether the individual will have enough money to provide for the needs of retirement. Rather, bern_c07.qxd 98 3/23/07 9:05 AM Page 98 THE THEORETICIANS Financial Engines furnishes the individual with the probable consequences of individual decisions based on a range of outcomes with which a person would be comfortable. The program is sophisticated, exciting, and crystal clear in the information it provides, and it is constantly being revised and improved by a skilled staff.

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As a financial adviser, the company has none of the usual conf licts of interest because it is beholden to no one—indeed, it is a popular tool among professional financial planners as well as among individuals who have access to it.* Employers originally retained Financial Engines to make available the expertise of more sophisticated investors to employees struggling with the complexities of a 401(k) plan and the myriad of investment products offered to them. Under these arrangements, and in addition to an online service, employees receive a complete personalized projection once a year showing how their plan is doing, not just in terms of the year’s investment results, but also in achieving their ultimate retirement goals. Even with the kinds of help the Financial Engines model can provide, most people today find these kinds of problems too complicated and lose interest.

A Primer for the Mathematics of Financial Engineering by Dan Stefanica

asset allocation, Black-Scholes formula, capital asset pricing model, constrained optimization, delta neutral, discrete time, Emanuel Derman, financial engineering, implied volatility, law of one price, margin call, quantitative trading / quantitative finance, risk free rate, Sharpe ratio, short selling, time value of money, transaction costs, volatility smile, yield curve, zero-coupon bond

Financial Engineering Advanced Background Series Published or forthcoming 1. A Primer for the Mathematics of Financial Engineering, by Dan Stefanica 2. Numerical Linear Algebra Methods for Financial Engineering Applications, by Dan Stefanica 3. A Probability Primer for Mathematical Finance, by.Elena Kosygina 4. Differential Equations with Numerical Methods for Financial Engineering, by Dan Stefanica A PRIMER for the MATHEMATICS of FINANCIAL ENGINEERING DAN STEFANICA Baruch College City University of New York FE PRESS New York FE PRESS New York www.fepress.org Information on this title: www.fepress.org/mathematicaLprimer ©Dan Stefanica 2008 All rights reserved.

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The connection built during their studies has continued over the years, and as alumni of the program their contribution to the continued success of our students has been tremendous. This is the first in a series of books containing mathematical background needed for financial engineering applications, to be followed by books in N umerical Linear Algebra, Probability, and Differential Equations. Dan Stefanica New York, 2008 Acknow ledgments I have spent several wonderful years at Baruch College, as Director of the Financial Engineering Masters Program. Working with so many talented students was a privilege, as well as a learning experience in itself, and seeing a strong community develop around the MFE program was incredibly rewarding.

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Dan Stefanic a IBaruch MFE Program web page: http://www.baruch.cuny.edu/math/masters.html QuantNetwork student forum web page: http://www.quantnet.org/forum/index.php New York, 2008 xv How to Use This Book While we expect a large audience to find this book useful, the approach to reading the book will be different depending on the background and goals of the reader. Prospective students for financial engineering or mathematical finance programs should find the study of this book very rewarding, as it will give them a head start in their studies, and will provide a reference book throughout their course of study. Building a solid base for further study is of tremendous importance. This book teaches core concepts important for a successful learning experience in financial engineering graduate programs. Instructors of quantitative finance courses will find the mathematical topics and their treatment to be of greatest value, and could use the book as a reference text for a more advanced treatment of the mathematical content of the course they are teaching.

Tailspin: The People and Forces Behind America's Fifty-Year Fall--And Those Fighting to Reverse It by Steven Brill

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, 2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, activist fund / activist shareholder / activist investor, affirmative action, Affordable Care Act / Obamacare, airport security, American Society of Civil Engineers: Report Card, asset allocation, behavioural economics, Bernie Madoff, Bernie Sanders, Blythe Masters, Bretton Woods, business process, call centre, Capital in the Twenty-First Century by Thomas Piketty, carbon tax, Carl Icahn, carried interest, clean water, collapse of Lehman Brothers, collective bargaining, computerized trading, corporate governance, corporate raider, corporate social responsibility, Credit Default Swap, currency manipulation / currency intervention, deal flow, Donald Trump, electricity market, ending welfare as we know it, failed state, fake news, financial deregulation, financial engineering, financial innovation, future of work, ghettoisation, Glass-Steagall Act, Gordon Gekko, hiring and firing, Home mortgage interest deduction, immigration reform, income inequality, invention of radio, job automation, junk bonds, knowledge economy, knowledge worker, labor-force participation, laissez-faire capitalism, low interest rates, Mahatma Gandhi, Mark Zuckerberg, Michael Milken, military-industrial complex, mortgage tax deduction, Neil Armstrong, new economy, Nixon triggered the end of the Bretton Woods system, obamacare, old-boy network, opioid epidemic / opioid crisis, paper trading, Paris climate accords, performance metric, post-work, Potemkin village, Powell Memorandum, proprietary trading, quantitative hedge fund, Ralph Nader, ride hailing / ride sharing, Robert Bork, Robert Gordon, Robert Mercer, Ronald Reagan, Rutger Bregman, Salesforce, shareholder value, Silicon Valley, Social Responsibility of Business Is to Increase Its Profits, stock buybacks, Tax Reform Act of 1986, tech worker, telemarketer, too big to fail, trade liberalization, union organizing, Unsafe at Any Speed, War on Poverty, women in the workforce, working poor

INSURING AGAINST RECKLESS GAMBLES Two toxic ingredients that would be key factors in America’s tailspin had come together: A preoccupation with financial engineering aimed at enabling ever more aggressive betting on paper instruments had combined with still more engineering that allowed for those facilitating the bets to avoid accountability for the risks they were creating—risks whose consequences would ultimately be suffered far beyond the financial community. In fact, there would soon be a way for wary buyers of mortgage-backed securities to pass off their own risk completely. The financial engineering hero this time was Blythe Masters, a twenty-five-year-old, Cambridge-educated banker in JPMorgan’s London office.

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Then, in a way unprecedented in history, they were able to consolidate their winnings, outsmart and co-opt the government that might have reined them in, and pull up the ladder so more could not share in their success or challenge their primacy. By continuing to get better at what they do, by knocking away the guardrails limiting their winnings, by aggressively engineering changes in the political landscape, and by dint of the often unanticipated consequences of the breakthroughs they pulled off in legal rights, financial engineering, digital technology, political strategy, and so many other areas, they created a nation of moats that protected them from accountability and from the damage their triumphs caused in the larger community. Most of the time, our elected and appointed representatives were no match for these overachievers.

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Although the chapters that follow each focus on one element of the breakdown, the elements were interrelated. For example, the rise of meritocracy that created a newly entrenched aristocracy of knowledge workers powered the transformation of America into a finance-dominated economy. That in turn created still more demand for financial engineers and lawyers, which further entrenched the meritocracy and widened income inequality. Similarly, the emergence of the First Amendment as a tool enabling unlimited money to finance campaign contributions and to pay for lobbyists to dominate Washington allowed business interests to prevail in multiple battles against the middle class, including fights over unionization.

The Volatility Smile by Emanuel Derman,Michael B.Miller

Albert Einstein, Asian financial crisis, Benoit Mandelbrot, Black Monday: stock market crash in 1987, book value, Brownian motion, capital asset pricing model, collateralized debt obligation, continuous integration, Credit Default Swap, credit default swaps / collateralized debt obligations, discrete time, diversified portfolio, dividend-yielding stocks, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial engineering, fixed income, implied volatility, incomplete markets, law of one price, London Whale, mandelbrot fractal, market bubble, market friction, Myron Scholes, prediction markets, quantitative trading / quantitative finance, risk tolerance, riskless arbitrage, Sharpe ratio, statistical arbitrage, stochastic process, stochastic volatility, transaction costs, volatility arbitrage, volatility smile, Wiener process, yield curve, zero-coupon bond

A secondary motivation for writing this book originates in the great financial crisis of 2007–2008, which began with the collapse of the mortgage collateralized debt obligation (CDO) market, whose structured credit products were valued using financial engineering techniques. When the crisis began, some pundits blamed the practice of financial engineering for the mortgage market’s meltdown. Paul Volcker, whose grandson was a financial engineer, wrote the following paragraph as part of an otherwise sensible speech he gave in 2009: A year or so ago, my daughter had seen . . . some disparaging remarks I had made about financial engineering. She sent it to my grandson, 1 2 THE VOLATILITY SMILE who normally didn’t communicate with me very much.

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Engineering is about using those principles, constructively, to create functional devices. What about financial engineering? In a logically consistent world, financial engineering, layered above a solid base of financial science, would be the study of how to create useful financial devices (convertible bonds, warrants, volatility swaps, etc.) that perform in desired ways. This brings us to financial science, the putative study of the fundamental laws of financial objects, be they stocks, interest rates, or whatever else your theory uses as constituents. Here, unfortunately, be dragons. Financial engineering rests upon the mathematical fields of calculus, probability theory, stochastic processes, simulation, and Brownian motion.

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These products include equity options granted to executives, embedded derivatives in convertible bonds, and many other customized fixed income and equity derivatives. Prior to this, he studied financial engineering at Columbia University, and physics at the University of Toronto. xv CHAPTER 1 Overview Financial models in light of the great financial crisis. The difficulties of option valuation. An introduction to the volatility smile. Financial science and financial engineering. The purpose and use of models. INTRODUCTION Our primary aim in this book is to provide the reader with an accessible, not-too-sophisticated introduction to models of the volatility smile.

Mathematics for Finance: An Introduction to Financial Engineering by Marek Capinski, Tomasz Zastawniak

Black-Scholes formula, Brownian motion, capital asset pricing model, cellular automata, delta neutral, discounted cash flows, discrete time, diversified portfolio, financial engineering, fixed income, interest rate derivative, interest rate swap, locking in a profit, London Interbank Offered Rate, margin call, martingale, quantitative trading / quantitative finance, random walk, risk free rate, short selling, stochastic process, time value of money, transaction costs, value at risk, Wiener process, zero-coupon bond

Howie Sets, Logic and Categories P. Cameron Special Relativity N.M.J. Woodhouse Symmetries D.L. Johnson Topics in Group Theory G. Smith and O. Tabachnikova Topologies and Uniformities I.M. James Vector Calculus P.C. Matthews Marek Capiński and Tomasz Zastawniak Mathematics for Finance An Introduction to Financial Engineering With 75 Figures 1 Springer Marek Capiński Nowy Sacz School of Business–National Louis University, 33-300 Nowy Sacz, ul. Zielona 27, Poland Tomasz Zastawniak Department of Mathematics, University of Hull, Cottingham Road, Kingston upon Hull, HU6 7RX, UK Cover illustration elements reproduced by kind permission of: Aptech Systems, Inc., Publishers of the GAUSS Mathematical and Statistical System, 23804 S.E.

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Option Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173 8.1 European Options in the Binomial Tree Model . . . . . . . . . . . . . . . 174 8.1.1 One Step . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174 8.1.2 Two Steps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176 8.1.3 General N -Step Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178 8.1.4 Cox–Ross–Rubinstein Formula . . . . . . . . . . . . . . . . . . . . . . . 180 8.2 American Options in the Binomial Tree Model . . . . . . . . . . . . . . . 181 8.3 Black–Scholes Formula . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185 9. Financial Engineering . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191 9.1 Hedging Option Positions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192 9.1.1 Delta Hedging . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192 9.1.2 Greek Parameters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197 9.1.3 Applications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199 9.2 Hedging Business Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 9.2.1 Value at Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202 9.2.2 Case Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203 9.3 Speculating with Derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208 9.3.1 Tools . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208 9.3.2 Case Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209 10.

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The option price is computed in two ways, as a function of the time T remaining before the option is exercised: a) (solid line) from the Black–Scholes formula for T between 0 and 1; b) (dots) using the Cox–Ross–Rubinstein formula with T increasing from 0 to 1 in N = 10 steps of duration τ = 0.1 each; the discrete growth rates for each step are computed using formulae (3.7). Even with as few as 10 steps there is remarkably good agreement between the discrete and continuous time formulae. 9 Financial Engineering This chapter shows some applications of derivative securities to managing the risk exposure in various situations. The presentation will be by means of examples and mini case studies. Even though these are concerned with very particular circumstances, the methods are applicable to a wide range of tasks handled by financial managers.

Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, additive manufacturing, Airbnb, Alan Greenspan, algorithmic trading, Alvin Roth, Asian financial crisis, asset allocation, bank run, Basel III, Bear Stearns, behavioural economics, Big Tech, bonus culture, Bretton Woods, British Empire, business cycle, buy and hold, call centre, Capital in the Twenty-First Century by Thomas Piketty, Carl Icahn, Carmen Reinhart, carried interest, centralized clearinghouse, clean water, collateralized debt obligation, commoditize, computerized trading, corporate governance, corporate raider, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, crowdsourcing, data science, David Graeber, deskilling, Detroit bankruptcy, diversification, Double Irish / Dutch Sandwich, electricity market, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial deregulation, financial engineering, financial intermediation, Ford Model T, Frederick Winslow Taylor, George Akerlof, gig economy, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Greenspan put, guns versus butter model, High speed trading, Home mortgage interest deduction, housing crisis, Howard Rheingold, Hyman Minsky, income inequality, index fund, information asymmetry, interest rate derivative, interest rate swap, Internet of things, invisible hand, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", John Bogle, John Markoff, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, Kickstarter, knowledge economy, labor-force participation, London Whale, Long Term Capital Management, low interest rates, manufacturing employment, market design, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, offshore financial centre, oil shock, passive investing, Paul Samuelson, pensions crisis, Ponzi scheme, principal–agent problem, proprietary trading, quantitative easing, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, Rana Plaza, RAND corporation, random walk, rent control, Robert Shiller, Ronald Reagan, Satyajit Das, Savings and loan crisis, scientific management, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, Snapchat, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, Steve Jobs, stock buybacks, subprime mortgage crisis, technology bubble, TED Talk, The Chicago School, the new new thing, The Spirit Level, The Wealth of Nations by Adam Smith, Tim Cook: Apple, Tobin tax, too big to fail, Tragedy of the Commons, trickle-down economics, Tyler Cowen: Great Stagnation, Vanguard fund, vertical integration, zero-sum game

Eleven percent of the undergraduate class at MIT, for example, now goes to Wall Street, and despite the 2008 crisis, financial engineering is the fastest-growing field at many of the country’s best engineering schools.58 “Not only are these people not making scientific progress,” says Greg Smith, the former Goldman Sachs quantitative trader who famously published his resignation letter in the New York Times, “but the complex derivatives products they create are being sold to unsuspecting public pension funds and investors [who don’t know any better]. So there is actually an argument to be made that diverting our smartest PhDs to finance is a waste, at best, and detrimental to [overall economic growth] at worst.”59 It’s an argument that even some of the financial engineers themselves would agree with. Derman, who runs the financial engineering program at Columbia, says that despite the blowback against risky Wall Street trading in the wake of the financial crisis, demand for his classes is as strong as ever. The only thing that’s changed, says Derman, “is that students today aren’t content to be just traders at a bank; they want to be principals [meaning, heads of their own hedge funds].”

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Part of the reason is that Apple hasn’t introduced any truly game-changing technology since Jobs’s death in 2011. That has at times depressed the company’s stock price and led to concerns about its long-term future, despite the fact that it still sells a heck of a lot of devices. It’s a chicken-and-egg cycle, of course. The more a company focuses on financial engineering rather than the real kind, the more it ensures it will need to continue to do so. But right now, what Apple does have is cash. Which gets us to that $17 billion. Apple didn’t need that money to build a new plant or to develop a new product line. It needed the funds to buy off investors by repurchasing stock and fattening dividends, which would goose the company’s lagging share price.

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David Einhorn, the hedge fund manager who’d long been complaining that the company wasn’t sharing enough of its cash hoard, inadvertently put it very well when he said that Apple should apply “the same level of creativity” on its balance sheet as it does to producing revolutionary products.1 To him, and to many others in corporate America today, one kind of creativity is just as good as another. I’ll argue differently in this book. The fact that Apple, probably the best-known company in the world and surely one of the most admired, now spends a large amount of its time and effort thinking about how to make more money via financial engineering rather than by the old-fashioned kind, tells us how upside down our biggest corporation’s priorities have become, not to mention the politics behind a tax system that encourages it all. This little vignette also demonstrates how detached many of America’s biggest businesses have become from the needs and desires of their consumers—and from the hearts and minds of the country at large.

Solutions Manual - a Primer for the Mathematics of Financial Engineering, Second Edition by Dan Stefanica

asset allocation, Black-Scholes formula, constrained optimization, delta neutral, financial engineering, implied volatility, law of one price, risk free rate, yield curve, zero-coupon bond

The Solutions Ivlanual will be an important resource for prospective financial engineering graduate students. Studying the material from the Math Primer in tandem with the Solutions Manual would provide the solid mathematical background required for successful graduate studies. The author has been the Director of the Baruch College MFE Program 1 since its inception in 2002. Over 90 percent of the graduates of the Baruch IvIFE Program are currently employed i口 the financial industry. "A Primer for the Ivlathematics of Financial Engineering" and this Solutions Manual are the first books to appear in the Financial Engineering Advanced Backgrou日d Series.

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Books on Numerical Linear Algebra , on Probability, and on Differential Equations for financial engineering applications are forthcommg. Dan Stefanica New York , 2008 lBaruch MFE Program web page: http://www.baruch.cuny.edu/math/master 山tml QuantNetwork student forum web page: httr旷/ www.quantnet.org/forum/index 抖lp IX Acknowledgments "A Primer for the Mathematics of Financial Engineering" published in April 2008 , is based on material covered in a mathematics refresher course I taught to students entering the Financial Engineering Masters Program at Baruch College. Using the book as the primary text in the July 2008 refresher course was a challenging but exceptionally rewarding experience.

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Bibliography by substitu161 . . . . . . . . . 161 . . . . . . . . . 171 . . . . . . . . . 173 Implied volatil179 . . . . . . . . . . . 179 . . . . . . . . . . . 197 . . . . . . . . . . . 198 203 Preface The addition of this Solutions Ivlanual to "A Primer for the Mathematics of Financial Engineering" offers the reader the opportunity to undertake rigorous self-study of the mathematical topics presented in the Ivlath Primer , with the goal of achieving a deeper understanding of the financial applications therein. Every exercise from the Math Primer is solved in detail in the Solutions Manual. Over 50 new exercises are included , and complete solutions to these supplemental exercises are provided. 如1any of these exercises are quite challenging and offer insight that promises to be most useful in further financial engineering studies as well as job interviews.

King Icahn: The Biography of a Renegade Capitalist by Mark Stevens

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", Bear Stearns, book value, Carl Icahn, classic study, company town, corporate governance, corporate raider, Donald Trump, financial engineering, flag carrier, Gordon Gekko, Irwin Jacobs, junk bonds, laissez-faire capitalism, low interest rates, Michael Milken, old-boy network, Ponzi scheme, profit motive, shareholder value, yellow journalism

That was really going to take us to the top.” From Ashwood’s perspective, those who trusted Carl to rebuild TWA were naïve from the outset. “A leopard doesn’t change his spots. Icahn was, and is, a financial engineer. He can’t run a business. He can’t run a corner deli. If he ran the deli and the freezer broke, he wouldn’t fix it. He’d try to sell the spoiled milk rather than have the freezer fixed.” Through his financial engineering, Icahn had created a Frankenstein monster of ill will within his own organization. Soon after the privatization, viscous slurs were scrawled on the walls of TWA hangars and an oven in a jumbo jet’s lower galley read, “Hey, Carl, this one’s for you.”

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With this idea Icahn launched his first major move to control corporate destinies, and in turn, to earn the kind of windfall profits he believed were awaiting those gifted strategists who saw the opportunities in the system and had the gumption to exploit them. Standing at the vanguard of a new form of financial engineering that would have a cataclysmic impact on American capitalism, Icahn would fire his opening salvos at Baird & Warner, a slumping real estate investment trust (REIT), and a sleepy, Mansfield, Ohio-based range and oven maker, the Tappan Company. When Icahn launched his offensive against Baird & Warner Mortgage & Realty Investors, the Chicago-based REIT was run by John Baird, a prominent figure in the local business community.

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In the past, the best and brightest in America had built their wealth and their reputations by creating powerful, innovative companies that became world leaders in commerce and industry. But because intense foreign competition and corporate inefficiencies were taking a heavy toll on the traditional means of creating wealth, financial engineering emerged as an appealing alternative. Rather than financing companies forced to compete with the increasingly potent Japanese, Germans and Koreans, growing ranks of U.S. bankers switched allegiance to the financial alchemists who were promising and delivering bigger, faster gains with minimum risk.

Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", "there is no alternative" (TINA), "World Economic Forum" Davos, affirmative action, Alan Greenspan, Albert Einstein, algorithmic trading, Andy Kessler, AOL-Time Warner, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Bear Stearns, behavioural economics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, book value, Bretton Woods, BRICs, British Empire, business cycle, buy the rumour, sell the news, capital asset pricing model, carbon credits, Carl Icahn, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, Daniel Kahneman / Amos Tversky, deal flow, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Dr. Strangelove, Dutch auction, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Fall of the Berlin Wall, financial engineering, financial independence, financial innovation, financial thriller, fixed income, foreign exchange controls, full employment, Glass-Steagall Act, global reserve currency, Goldman Sachs: Vampire Squid, Goodhart's law, Gordon Gekko, greed is good, Greenspan put, happiness index / gross national happiness, haute cuisine, Herman Kahn, high net worth, Hyman Minsky, index fund, information asymmetry, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", job automation, Johann Wolfgang von Goethe, John Bogle, John Meriwether, joint-stock company, Jones Act, Joseph Schumpeter, junk bonds, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, low interest rates, margin call, market bubble, market fundamentalism, Market Wizards by Jack D. Schwager, Marshall McLuhan, Martin Wolf, mega-rich, merger arbitrage, Michael Milken, Mikhail Gorbachev, Milgram experiment, military-industrial complex, Minsky moment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, Naomi Klein, National Debt Clock, negative equity, NetJets, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, Paul Samuelson, pets.com, Philip Mirowski, Phillips curve, planned obsolescence, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, proprietary trading, public intellectual, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, Reminiscences of a Stock Operator, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Thaler, Right to Buy, risk free rate, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, Satyajit Das, savings glut, shareholder value, Sharpe ratio, short selling, short squeeze, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, stock buybacks, survivorship bias, tail risk, Teledyne, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, the new new thing, The Predators' Ball, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, two and twenty, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond, zero-sum game

In 2001, when the Internet bubble burst, Merrill was there front and center. The pattern would repeat with CDO investments in 2008 under Stan O’Neal. In 1987 a trade journal warned: “For Wall Street in general, Merrill’s loss is a reminder of the dangers of financial engineering.... The pace of innovation has been breathtaking. Unfortunately, the growth in understanding has been less impressive.”7 No one understood what economic commentator James Grant stated: “Financial engineering is the science of structuring cash flows...credit analysis is the art of getting paid.”8 Risk would return over and over via new structures, each time bigger and more toxic than the last.

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See also money FIBS (France, Italy, Britain, and the States), 354 FiDi (Financial District), 80 Fiennes, Ralph, 153 finance careers, 307-313 bonuses, 317-318 compensation, 313-320 finance certifications, 309-310 Financial Accounting Standard Board (FASB), 286 financial alchemy, 131-132 financial centers, 82-88 financial crises, preparation for, 264-278 Financial Crisis Inquiry Commission (FCIC), 291, 302, 325 financial districts, London, 53 financial engineering, 55-57 financial engineers, 308 financial frontiers, 52 financial gravity, 347 financial groupthink, 296-297 financial institutions, networks, 270 financial markets, deregulation of, 279 financial news, 89 newspapers, 89-91 video, 91-99 financial pornography, 92 Financial Products (FP), 230 Financial Services Authority (FSA), 81, 236 financial sponsors, 154 financial statements bad loans (2008), 343-344 falsifying, 289-291 financial supermarkets, 67, 75 financial system, deregulation of, 66 Financial Times (FT), 38, 89, 206, 280, 298, 310, 329-330, 351 Joel Stern, 124 ShokcGen, 226 financialization, 20, 38, 41, 54-57 General Electric (GE), 59-62 Japan, 38-39 management, 63 financiers celebrity, 324-326 end of bubble, 332 Fink, Lawrence, 170 firewalls, 66 First Boston, 134, 170 First Executive Insurance, 145 First Investors Fund for Income, 145 First World War, 34, 74, 103 first-to-default (FtD) swaps, 220-221 Fisher, Irving, 35, 98, 268 Fitch, 141, 282 Fitzgerald, F.

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—James Pressley, Bloomberg “Long before the 2008-09 credit crisis and collapse, one of the strongest warnings about the dangers of derivatives came from Satyajit Das.... it reads more like a crime novel than a financial book.” —Barry Ritholtz “...a scalpel of a book that pulls back the skin on the derivatives and risk management industry to expose the blood, guts and circulatory system underneath.” —Nina Mehta, Financial Engineering News “Traders, Guns & Money is one the most entertaining investment books I’ve read in a long time...this is possibly the best insider account of a career in investments since Michael Lewis’s book Liar’s Poker.” —www.dna.bloggingstocks.com “...this revealing insider’s account ...the book is peppered with cautionary tales ...Das wittily exposes the mechanisms behind the arcane language....”

The Price of Time: The Real Story of Interest by Edward Chancellor

"World Economic Forum" Davos, 3D printing, activist fund / activist shareholder / activist investor, Airbnb, Alan Greenspan, asset allocation, asset-backed security, assortative mating, autonomous vehicles, balance sheet recession, bank run, banking crisis, barriers to entry, Basel III, Bear Stearns, Ben Bernanke: helicopter money, Bernie Sanders, Big Tech, bitcoin, blockchain, bond market vigilante , bonus culture, book value, Bretton Woods, BRICs, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, cashless society, cloud computing, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, commodity super cycle, computer age, coronavirus, corporate governance, COVID-19, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cryptocurrency, currency peg, currency risk, David Graeber, debt deflation, deglobalization, delayed gratification, Deng Xiaoping, Detroit bankruptcy, distributed ledger, diversified portfolio, Dogecoin, Donald Trump, double entry bookkeeping, Elon Musk, equity risk premium, Ethereum, ethereum blockchain, eurozone crisis, everywhere but in the productivity statistics, Extinction Rebellion, fiat currency, financial engineering, financial innovation, financial intermediation, financial repression, fixed income, Flash crash, forward guidance, full employment, gig economy, Gini coefficient, Glass-Steagall Act, global reserve currency, global supply chain, Goodhart's law, Great Leap Forward, green new deal, Greenspan put, high net worth, high-speed rail, housing crisis, Hyman Minsky, implied volatility, income inequality, income per capita, inflation targeting, initial coin offering, intangible asset, Internet of things, inventory management, invisible hand, Japanese asset price bubble, Jean Tirole, Jeff Bezos, joint-stock company, Joseph Schumpeter, junk bonds, Kenneth Rogoff, land bank, large denomination, Les Trente Glorieuses, liquidity trap, lockdown, Long Term Capital Management, low interest rates, Lyft, manufacturing employment, margin call, Mark Spitznagel, market bubble, market clearing, market fundamentalism, Martin Wolf, mega-rich, megaproject, meme stock, Michael Milken, Minsky moment, Modern Monetary Theory, Mohammed Bouazizi, Money creation, money market fund, moral hazard, mortgage debt, negative equity, new economy, Northern Rock, offshore financial centre, operational security, Panopticon Jeremy Bentham, Paul Samuelson, payday loans, peer-to-peer lending, pensions crisis, Peter Thiel, Philip Mirowski, plutocrats, Ponzi scheme, price mechanism, price stability, quantitative easing, railway mania, reality distortion field, regulatory arbitrage, rent-seeking, reserve currency, ride hailing / ride sharing, risk free rate, risk tolerance, risk/return, road to serfdom, Robert Gordon, Robinhood: mobile stock trading app, Satoshi Nakamoto, Satyajit Das, Savings and loan crisis, savings glut, Second Machine Age, secular stagnation, self-driving car, shareholder value, Silicon Valley, Silicon Valley startup, South Sea Bubble, Stanford marshmallow experiment, Steve Jobs, stock buybacks, subprime mortgage crisis, Suez canal 1869, tech billionaire, The Great Moderation, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, Thorstein Veblen, Tim Haywood, time value of money, too big to fail, total factor productivity, trickle-down economics, tulip mania, Tyler Cowen, Uber and Lyft, Uber for X, uber lyft, Walter Mischel, WeWork, When a measure becomes a target, yield curve

The numbers in the FinEng case study are hard to follow for anyone unfamiliar with corporate finance, but the important point is that the use of low-cost debt to repurchase shares artificially boosts profitability and stock valuations. Given that executive compensation is generally linked to measures that are enhanced by financial engineering – such as returns on equity, EPS growth and stock performance – senior management has a strong incentive to play the game. Short-term investors, bankers and senior corporate executives benefit from this financial engineering, but no one else is better off. The impulse for buybacks also came from outside the firm. Companies that underperformed in the stock market became takeover targets for competitors or private equity firms.

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The nation’s money supply and credit expanded rapidly while interest rates were held well below the economy’s GDP growth rate.5 Business investment soared. Japanese corporations, which issued foreign currency warrant bonds, enjoyed a negative cost of borrowing after swapping the proceeds back into yen. Financial engineering, known as zaitech, became commonplace: companies borrowed to speculate in stocks through their brokerage trust or tokkin accounts. Easy money fuelled a bubble in equities and property. The real estate value of the imperial palace in Tokyo was famously estimated to have surpassed that of the entire state of California.

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Too much debt accumulates. After the crisis, central bankers tried out new monetary measures – quantitative easing, paying banks interest on their reserves, zero and negative interest rates, and various other innovations. They stamped on the gas pedal whenever the economy lost momentum, or when the financial engine threatened to stall. The interest rate was floored but still the economic juggernaut continued to slow. All the signs pointed in the direction of ever lower rates. How to get back on track, Borio was asked. ‘If I were you,’ he replied, ‘I would not start from here.’22 It’s an old joke. He feared that monetary policy was losing efficacy.

Money Changes Everything: How Finance Made Civilization Possible by William N. Goetzmann

Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, banking crisis, Benoit Mandelbrot, Black Swan, Black-Scholes formula, book value, Bretton Woods, Brownian motion, business cycle, capital asset pricing model, Cass Sunstein, classic study, collective bargaining, colonial exploitation, compound rate of return, conceptual framework, Cornelius Vanderbilt, corporate governance, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, delayed gratification, Detroit bankruptcy, disintermediation, diversified portfolio, double entry bookkeeping, Edmond Halley, en.wikipedia.org, equity premium, equity risk premium, financial engineering, financial independence, financial innovation, financial intermediation, fixed income, frictionless, frictionless market, full employment, high net worth, income inequality, index fund, invention of the steam engine, invention of writing, invisible hand, James Watt: steam engine, joint-stock company, joint-stock limited liability company, laissez-faire capitalism, land bank, Louis Bachelier, low interest rates, mandelbrot fractal, market bubble, means of production, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, new economy, passive investing, Paul Lévy, Ponzi scheme, price stability, principal–agent problem, profit maximization, profit motive, public intellectual, quantitative trading / quantitative finance, random walk, Richard Thaler, Robert Shiller, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, spice trade, stochastic process, subprime mortgage crisis, Suez canal 1869, Suez crisis 1956, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, time value of money, tontine, too big to fail, trade liberalization, trade route, transatlantic slave trade, tulip mania, wage slave

He and the other directors were liable for the debts of the company. His anti-British sentiments may have been passed on to his son. In some places, however, American financial engineers got around the prohibition. In 1766, Maryland replaced its notes with a new security that could be redeemed for sterling—when presented in Britain! FOUNDING FATHERS The Bubble Act was extended to the colonies in 1741 to restrict financial engineering, but despite this regulatory restriction, American entrepreneurs pushed the financial envelope, particularly in land investments. America was one of the few exceptions to the global retreat from using stocks to finance business.

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However, the fundamental theme of economic expropriation by the state, legitimized by his clever use of Chinese history and ancient precedent—from invocations of the Guanzi to adaptations of the Zhouli—became part of the new lexicon of Chinese government rule. He may not have been the first to introduce the use of financial engineering in the service of the central state, but few politicians refined it as well as he did, using timeless and familiar populist rhetoric. CHINESE INNOVATION THROUGH WESTERN EYES Although it may be difficult for us today to imagine a world without paper money, we have a rare opportunity to see how wondrous this financial innovation appeared to a contemporary foreign observer.

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The only thing worse than selling life annuities at the wrong price is selling them to clever people who know precisely how best to exploit the mistake to their advantage. By 1770, European financiers had all read the new research on probability and life annuity valuations, even if government officials had not. With each new French government issue of life annuities, financial engineers in Holland and Switzerland bought them up and then issued bonds collateralized by the annuity cash flow. The securities issued by syndicates of Geneva-based bankers were among the most common. A Geneva investment syndicate would purchase French life annuities on the lives of thirty young girls at a time—trente demoiselles.

Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better by Andrew Palmer

Affordable Care Act / Obamacare, Alan Greenspan, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, behavioural economics, Black Monday: stock market crash in 1987, Black-Scholes formula, bonus culture, break the buck, Bretton Woods, call centre, Carmen Reinhart, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Graeber, diversification, diversified portfolio, Edmond Halley, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, eurozone crisis, family office, financial deregulation, financial engineering, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, impact investing, implied volatility, income inequality, index fund, information asymmetry, Innovator's Dilemma, interest rate swap, Kenneth Rogoff, Kickstarter, late fees, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, low interest rates, margin call, Mark Zuckerberg, McMansion, Minsky moment, money market fund, mortgage debt, mortgage tax deduction, Myron Scholes, negative equity, Network effects, Northern Rock, obamacare, payday loans, peer-to-peer lending, Peter Thiel, principal–agent problem, profit maximization, quantitative trading / quantitative finance, railway mania, randomized controlled trial, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Savings and loan crisis, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, subprime mortgage crisis, tail risk, Thales of Miletus, the long tail, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

As policy makers try to find a way to avoid bailing out banks in a future financial crisis, one answer is a new security issued by banks called “contingent convertible” bonds, or CoCos for short. The idea behind CoCos is that bondholders are forcibly converted into shareholders when a bank’s level of capital falls below a certain threshold, so that when a financial institution gets into trouble, its equity cushion is automatically plumped up. Financial engineering is one answer to a crisis partly caused by financial engineering. 21. Saumitra Jha, “Sharing the Future: Financial Innovation and Innovators in Solving the Political Economy Challenges of Development” (Stanford Graduate School of Business Research Paper 2093, 2011). 22. Alan Morrison and William Wilhelm Jr., Investment Banking: Institutions, Politics and Law (Oxford: Oxford University Press, 2007). 23.

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Some think this model—in which philanthropists, or perhaps government itself, guarantee that a portion of investors’ money is returned—is the way to bring in more capital. Another option is to blend the returns from SIBs with other assets. Allia, a British charity devoted to social investment, made a SIB available to retail investors for the first time in 2013. It made the risk acceptable with a simple bit of financial engineering. Of every £1,000 invested in the Allia bond, £780 goes to a fixed-rate loan to a social-housing provider, which when repaid with interest will give investors their £1,000 back. Another £200 goes into the SIB providing multisystemic therapy to troubled children in Essex, which offers investors the potential for an additional return.

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This “translational” period, which moves a promising piece of academic research into the early stages of testing for use in humans, is known to the industry as “the valley of death.” It is this part of the drug-discovery process, when risks are highest and capital is scarcest, that Andrew Lo wants to address. His goal is to unlock billions of dollars of funding for early-stage drugs. And to drum up interest, he and others have formulated a provocative question: “Can financial engineering cure cancer?”2 Lo is not an ivory-tower zealot. Well before the financial crisis, he was struck by the failure of the “efficient-market hypothesis” to grapple with the basics of human behavior. The essence of the efficient-markets hypothesis, which was formulated in 1970 by a University of Chicago economist named Eugene Fama, who shared the 2013 Nobel Prize for Economics, is that markets are rational.

Sabotage: The Financial System's Nasty Business by Anastasia Nesvetailova, Ronen Palan

Alan Greenspan, algorithmic trading, bank run, banking crisis, barriers to entry, Basel III, Bear Stearns, Bernie Sanders, big-box store, bitcoin, Black-Scholes formula, blockchain, Blythe Masters, bonus culture, Bretton Woods, business process, collateralized debt obligation, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, critique of consumerism, cryptocurrency, currency risk, democratizing finance, digital capitalism, distributed ledger, diversification, Double Irish / Dutch Sandwich, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, financial intermediation, financial repression, fixed income, gig economy, Glass-Steagall Act, global macro, Gordon Gekko, high net worth, Hyman Minsky, independent contractor, information asymmetry, initial coin offering, interest rate derivative, interest rate swap, Joseph Schumpeter, junk bonds, Kenneth Arrow, litecoin, London Interbank Offered Rate, London Whale, Long Term Capital Management, margin call, market fundamentalism, Michael Milken, mortgage debt, new economy, Northern Rock, offshore financial centre, Paul Samuelson, peer-to-peer lending, plutocrats, Ponzi scheme, Post-Keynesian economics, price mechanism, regulatory arbitrage, rent-seeking, reserve currency, Ross Ulbricht, shareholder value, short selling, smart contracts, sovereign wealth fund, Thorstein Veblen, too big to fail

Banks’ less serious misdeeds include, but are not confined to, the following: misleading statements to investors involving capital-raising rights issues; abusive lending practices to small businesses; manipulation of gold prices; misreporting related to Barclays emergency capital raising; a banker stealing confidential regulatory information; collusion with Greek authorities to mislead EU policymakers on meeting euro criteria; financial engineering with the aim of moving Italian debt off balance sheet; manipulation of risk models with the aim of minimizing reported risk-weighted assets/capital requirements; filing false statements with the SEC and keeping false books and records, or what has become known as the ‘London Whale’ story.10 The list is likely to be incomplete by the time this book is published.

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Some free-market economists conclude, therefore, that one can make profit in a competitive market only through innovation, a process to be nurtured and encouraged. There is no shortage of advice on how to do just that on bookshop shelves and online. There are, for instance, quantitative suggestions. Here, the competitive edge and high profits can be delivered by a sophisticated command of financial engineering and scientific precision in management. In the world of business studies the profitability conundrum can be resolved by strategic moves. Here, Keith Ward’s highly popular manual, now into its fourth edition, offers a typical solution: In order to create this value, the company has to develop and then exploit one or more sustainable competitive advantages, which will allow it to earn super profits on a continuing basis.

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Even if they know the client may be putting themselves into great hardship by entering into a mortgage agreement, or even if they know the borrower is likely to be unable to pay, mortgage advisers have an incentive to try and persuade the clients to take a mortgage, and help them present their affairs in such a way that mortgage companies would issue the mortgages. Aware of such conflicts of interest, mortgage companies, in turn, devised schemes for passing the mortgages on to others. Enabled by the policies of deregulation and centred on the use of sophisticated financial engineering, these techniques transformed the financial system from the kind that Veblen analysed at the dawn of finance capitalism to its modern incarnation. Despite the great transformation, however, sabotage remains a central principle of business making in finance in the twenty-first century. Veblen wrote about industrial sabotage focusing on the business processes of the late nineteenth and early twentieth centuries.

Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das

accounting loophole / creative accounting, Alan Greenspan, Albert Einstein, Asian financial crisis, asset-backed security, Bear Stearns, beat the dealer, Black Swan, Black-Scholes formula, Bretton Woods, BRICs, Brownian motion, business logic, business process, buy and hold, buy low sell high, call centre, capital asset pricing model, collateralized debt obligation, commoditize, complexity theory, computerized trading, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, currency peg, currency risk, disinformation, disintermediation, diversification, diversified portfolio, Edward Thorp, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, financial engineering, financial innovation, fixed income, Glass-Steagall Act, Haight Ashbury, high net worth, implied volatility, index arbitrage, index card, index fund, interest rate derivative, interest rate swap, Isaac Newton, job satisfaction, John Bogle, John Meriwether, junk bonds, locking in a profit, Long Term Capital Management, low interest rates, mandelbrot fractal, margin call, market bubble, Marshall McLuhan, mass affluent, mega-rich, merger arbitrage, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mutually assured destruction, Myron Scholes, new economy, New Journalism, Nick Leeson, Nixon triggered the end of the Bretton Woods system, offshore financial centre, oil shock, Parkinson's law, placebo effect, Ponzi scheme, proprietary trading, purchasing power parity, quantitative trading / quantitative finance, random walk, regulatory arbitrage, Right to Buy, risk free rate, risk-adjusted returns, risk/return, Salesforce, Satyajit Das, shareholder value, short selling, short squeeze, South Sea Bubble, statistical model, technology bubble, the medium is the message, the new new thing, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, volatility smile, yield curve, Yogi Berra, zero-coupon bond

Managers could have been forgiven for thinking that the market only rewarded financial engineering not basic, if boring, business initiatives. Like Skinner’s rats, they pressed the button that gave them food. The fact that their compensation was increasingly linked to the share price through share options meant that in the future companies concentrated on financial rather than real engineering. Equity analysts increasingly couldn’t differentiate between ‘real’ earning and all the financial jiggery pokery that went on. Enron, Worldcom and Paramalat lay at the end of that road. Financial engineering quickly replaced actual engineering in most businesses.

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In return the dealer would pay OCM an amount calculated according to a complicated formula: DAS_C01.QXD 5/3/07 11:45 PM Page 11 P ro l o g u e 11 Maximum of [0; NP × {7 × [(LIBOR2 × 1/ LIBOR) – (LIBOR4 × LIBOR–3)]} × days in the month/360] Where NP LIBOR = $600 million = 6 month dollar LIBOR rates The financial engineering was dazzling but there was just one problem. The complex equation, if you did the algebra, always equalled zero. The dealer would never pay OCM anything but OCM would be paying the dealer $4 million each month for three years. This was the intended effect. That was the deal, almost. There was an ‘extension’ option.

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Perversely it was the conservative Japanese who took trading within corporations to a new level. They were slavish lovers of American management theory. They had used the work of Frederick Taylor and Edward Deming to revolutionize manufacturing; now, they would do the same with financial management. This was ‘zaitech’ or ‘zaiteku’ – financial engineering. The treasury, the financial function within companies, was to be a profit centre. Proponents had carefully studied the Disney profit statement from 1984 where the accounting department had been a major contributor to its profits. Zaiteku meant trading in financial instruments to earn revenues for the company.

Nerds on Wall Street: Math, Machines and Wired Markets by David J. Leinweber

"World Economic Forum" Davos, AI winter, Alan Greenspan, algorithmic trading, AOL-Time Warner, Apollo 11, asset allocation, banking crisis, barriers to entry, Bear Stearns, Big bang: deregulation of the City of London, Bob Litterman, book value, business cycle, butter production in bangladesh, butterfly effect, buttonwood tree, buy and hold, buy low sell high, capital asset pricing model, Charles Babbage, citizen journalism, collateralized debt obligation, Cornelius Vanderbilt, corporate governance, Craig Reynolds: boids flock, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Danny Hillis, demand response, disintermediation, distributed generation, diversification, diversified portfolio, electricity market, Emanuel Derman, en.wikipedia.org, experimental economics, fake news, financial engineering, financial innovation, fixed income, Ford Model T, Gordon Gekko, Hans Moravec, Herman Kahn, implied volatility, index arbitrage, index fund, information retrieval, intangible asset, Internet Archive, Ivan Sutherland, Jim Simons, John Bogle, John Nash: game theory, Kenneth Arrow, load shedding, Long Term Capital Management, machine readable, machine translation, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, market fragmentation, market microstructure, Mars Rover, Metcalfe’s law, military-industrial complex, moral hazard, mutually assured destruction, Myron Scholes, natural language processing, negative equity, Network effects, optical character recognition, paper trading, passive investing, pez dispenser, phenotype, prediction markets, proprietary trading, quantitative hedge fund, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Reminiscences of a Stock Operator, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Metcalfe, Ronald Reagan, Rubik’s Cube, Savings and loan crisis, semantic web, Sharpe ratio, short selling, short squeeze, Silicon Valley, Small Order Execution System, smart grid, smart meter, social web, South Sea Bubble, statistical arbitrage, statistical model, Steve Jobs, Steven Levy, stock buybacks, Tacoma Narrows Bridge, the scientific method, The Wisdom of Crowds, time value of money, tontine, too big to fail, transaction costs, Turing machine, two and twenty, Upton Sinclair, value at risk, value engineering, Vernor Vinge, Wayback Machine, yield curve, Yogi Berra, your tax dollars at work

Richard Rosenblatt CEO, Rosenblatt Securities “Nerds on Wall Street is a wild, funny ride though the technological changes that underpin modern financial markets. You will find yourself laughing out loud at what could otherwise be a dry subject. And, if you’re not careful, you might even learn something!” Richard R. Lindsey Chairman, International Association of Financial Engineers; Principal, Callcott Group LLC “If you’re interested in what computers are doing with your money, then this book is for you.” Richard Peterson MD Managing Director, MarketPsy Capital LLC; Author, Inside the Investor’s Brain “In David’s words, the stock market is a “victim not a cause” of the great mess of 2008.

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; Genetic Algorithms; Evolving Financial Models; An Early Lesson; Arbitrage and Predictive Strategies; Maximizing Predictability; Chromosomes for Forecasting Models; Fitness Functions for Forecasting Models; Use of the GA for Coping with a Combinatoric Explosion of Models; Genetically Optimized Forecasting Models in Hindsight; Genetic Algorithm Warning Label Chapter 9: The Text Frontier: AI, IA, and the New Research 203 Ten Pounds of News in a Five-Pound Bag; Pre-News and Disintermediation; More Pre-News on the Internet Contents ix Chapter 10: Collective Intelligence, Social Media, and Web Market Monitors 227 Investing with Crowds; Never Met a Data Vendor I Didn’t Like; Santa Claus Is Coming to Town; Counting Messages; Whisper Numbers—Ruined by Success; Monitoring Web Activity; More Web, More Warnings Chapter 11: Three Hundred Years of Stock Market Manipulations: From the Coffeehouse to the World Wide Web 253 The Power of Manipulation; A Classic Market Manipulation; The Very Model of a Modern Market Manipulator; Bluffing; How Communication Changes Market Manipulation; Anatomy of a Successful Manipulation; The Internet Era; Cyber-Manipulations; It’s Not Just Micro-Caps; Where Are We Headed? Part Four Nerds Gone Wild: Wired Markets in Distress 273 Chapter 12: Shooting the Moon: Stupid Financial Technology Tricks 279 To Protect and to Serve; Stupid Engineering Tricks; Stupid Financial Engineering Tricks; Take Them Out and Shoot Them; Tech Hall of Shame; Quants Who Saw It Coming Chapter 13: Structural Ideas for the Economic Rescue: Fractional Homes and New Banks 305 Fractional Home Ownership; New American Bank Initiative; Still Mad, but Ever Hopeful Chapter 14: Nerds Gone Green: Nerds on Wall Street, off Wall Street 327 Accelerating Innovation; From the Vault; Billions of Dollars and Millions of Tons of Carbon; Epilogue; Web Site Index 343 About the Web Site NerdsonWallStreet.com 353 Foreword Q uantitative finance is not a topic usually associated with laughter.

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If the level of regulation, reporting, and transparency we have in the equity markets were in effect for the toxic garbage that is being laid off on the U.S. taxpayers, we wouldn’t be in the bind we are in. We should not blame anyone using a computer on Wall Street for the trouble. But we should blame the financial engineers who designed these Frankenstein derivatives and then failed to point out loudly and emphatically enough that their pricing models for these were so far out of the range of applicability based on previous experience that a horrendously dangerous situation had been created. Imagine if the designers of the first skyscrapers had said, “We can build a pretty good two-story house out of wood.

Unconventional Success: A Fundamental Approach to Personal Investment by David F. Swensen

asset allocation, asset-backed security, Benchmark Capital, book value, buy and hold, capital controls, classic study, cognitive dissonance, corporate governance, deal flow, diversification, diversified portfolio, equity risk premium, financial engineering, fixed income, index fund, junk bonds, law of one price, Long Term Capital Management, low interest rates, market bubble, market clearing, market fundamentalism, money market fund, passive investing, Paul Samuelson, pez dispenser, price mechanism, profit maximization, profit motive, risk tolerance, risk-adjusted returns, Robert Shiller, Savings and loan crisis, shareholder value, Silicon Valley, Steve Ballmer, stocks for the long run, survivorship bias, technology bubble, the market place, transaction costs, Vanguard fund, yield curve, zero-sum game

Market depth implies a substantial volume of offerings for individual positions. Market investability assures access by investors to investment opportunities. The basic building blocks for investor portfolios come from well-established, enduring marketplaces, not from trendy concoctions promoted by Wall Street financial engineers. Core asset classes encompass stocks, bonds, and real estate. Asset classes that investors employ to drive portfolio returns include domestic equities, foreign developed market equities, and emerging market equities. Asset classes that investors use to create diversification include U.S. Treasury bonds, which promise protection from financial catastrophe, and U.S.

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Holders of fallen angels find their interests at odds with the interests of corporate management. In the case of new-issue junk bonds, particularly those employed to finance leveraged-buyout deals or leveraged-recapitalization transactions, bondholders confront even more highly motivated, adversarial management groups. Sophisticated, equity-oriented financial engineers bring numerous tools to bear on the problem of increasing equity values substantially and rapidly. As the financial operators work to minimize the cost of debt, the bondholders realize the mirror image of cost minimization in the form of return diminution. Market Characteristics At December 31, 2003, the market value of high-yield corporate bonds totaled $550 billion.

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Whether the premium constitutes fair compensation for the complex options embedded in mortgage securities poses an extremely difficult question. Wall Street’s version of rocket scientists employ complicated computer models in a quest to determine the fair value of mortgage-backed securities. Sometimes the models work, sometimes not. If financial engineers face challenges in getting the option pricing right, what chance do individual investors have? Optionality proves even more difficult to assess than credit risk. In the case of fixed-income instruments with credit risk, sensible investors look at bond yields with skepticism, knowing that part of the return may be lost to corporate downgrades or defaults.

Taming the Sun: Innovations to Harness Solar Energy and Power the Planet by Varun Sivaram

"World Economic Forum" Davos, accelerated depreciation, addicted to oil, Albert Einstein, An Inconvenient Truth, asset light, asset-backed security, autonomous vehicles, bitcoin, blockchain, carbon footprint, carbon tax, clean tech, collateralized debt obligation, Colonization of Mars, currency risk, decarbonisation, deep learning, demand response, disruptive innovation, distributed generation, diversified portfolio, Donald Trump, electricity market, Elon Musk, energy security, energy transition, financial engineering, financial innovation, fixed income, gigafactory, global supply chain, global village, Google Earth, hive mind, hydrogen economy, index fund, Indoor air pollution, Intergovernmental Panel on Climate Change (IPCC), Internet of things, low interest rates, M-Pesa, market clearing, market design, Masayoshi Son, mass immigration, megacity, Michael Shellenberger, mobile money, Negawatt, ocean acidification, off grid, off-the-grid, oil shock, peer-to-peer lending, performance metric, renewable energy transition, Richard Feynman, ride hailing / ride sharing, rolling blackouts, Ronald Reagan, Silicon Valley, Silicon Valley startup, smart grid, smart meter, SoftBank, Solyndra, sovereign wealth fund, Ted Nordhaus, Tesla Model S, time value of money, undersea cable, vertical integration, wikimedia commons

Can the broader solar industry avoid the perils of too much leverage while still using financial engineering to expand the available pool of capital? Securitization Blanket At first blush, it might be unsettling that the financial trick that some solar companies are using to attract cheaper debt capital is the same maneuver that helped cause the Great Recession. Investment banks used that trick, securitization, to bundle, slice, and dice subprime mortgage loans from around the country. They managed to hoodwink the ratings agencies into certifying that the resulting high-risk derivatives were low-risk, but no amount of financial engineering could take garbage in and spit anything but garbage out.

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Christopher Martin, “SunEdison Emerging as Solar ‘Supermajor’ with $2.2 Billion Deal,” Bloomberg, July 20, 2015, https://www.bloomberg.com/news/articles/2015-07-20/sunedison-agrees-to-acquire-vivint-solar-for-2-2-billion. 3.  Antoine Gara, “SunEdison’s Big Slide: When Financial Engineering Goes Wrong,” Forbes, November 13, 2015, http://www.forbes.com/sites/antoinegara/2015/11/13/sunedisons-big-slide-when-financial-engineering-goes-wrong/. 4.  Stephen Foley and Ed Crooks, “SunEdison: Death of a Solar Star,” Financial Times, April 21, 2016, https://www.ft.com/content/04fca062-07a3-11e6-a70d-4e39ac32c284. 5.  Angus McCrone and Michael Liebreich, “Yieldcos—Two Big Questions,” Bloomberg New Energy Finance, July 30, 2015, https://about.bnef.com/blog/mccrone-liebreich-yieldcos-two-big-questions/. 6.  

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Achieving the latter will require three types of innovation. As part II explains, firms can apply financial and business model innovation to do more with existing solar PV technology. Today, solar PV still struggles to woo the colossal investors who regularly finance fossil-fuel projects. With some financial engineering, the solar industry could gain access to massive pools of low-cost investment to deploy solar on an unprecedented scale. Similarly, even though villagers in Africa or India are willing to pay for solar power, off-grid solar has been slow to take off. Now, a new crop of entrepreneurs are deftly combining mobile phones, big data, and conventional PV panels to reach these customers and make a profit doing so.

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead by Alan S. Blinder

Affordable Care Act / Obamacare, Alan Greenspan, asset-backed security, bank run, banking crisis, banks create money, Bear Stearns, book value, break the buck, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, Detroit bankruptcy, diversification, double entry bookkeeping, eurozone crisis, facts on the ground, financial engineering, financial innovation, fixed income, friendly fire, full employment, Glass-Steagall Act, hiring and firing, housing crisis, Hyman Minsky, illegal immigration, inflation targeting, interest rate swap, Isaac Newton, junk bonds, Kenneth Rogoff, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low interest rates, market bubble, market clearing, market fundamentalism, McMansion, Minsky moment, money market fund, moral hazard, naked short selling, new economy, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, Paul Volcker talking about ATMs, price mechanism, proprietary trading, quantitative easing, Ralph Waldo Emerson, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, shareholder value, short selling, South Sea Bubble, statistical model, the payments system, time value of money, too big to fail, vertical integration, working-age population, yield curve, Yogi Berra

But thinly traded or poorly understood securities are another matter entirely. Case in point: Theoretical valuation models based on EMH-type reasoning were used by Wall Street financial engineers to devise and price all sorts of exotic derivatives. History records that some of these calculations proved wide of the mark. Something New Under the Sun: CDS In the year 2000, a creative new type of derivative called a credit default swap (CDS) began to emerge. Its origins can be traced back a few years earlier, to a team of bright young financial engineers at JP Morgan in the 1990s. When I was vice chairman of the Federal Reserve in the mid-1990s, the Fed staff was just educating us about this unfamiliar new instrument, and we were trying to figure out what kind of beast it was.

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When the foxes have legions of accomplices, the perils are commensurately greater. And when both ideology and incentives conspire to make the authorities look the other way, well, chicken dinner is served. Sadly, that was the case in America during the boom years, when regulators stopped regulating, underwriters stopped underwriting, and financial engineering ran amok. The first two villains were bubbles and leverage. We now turn our attention to the other five members of the hall of shame, beginning with the abysmal performances of the nation’s financial regulatory agencies. VILLAIN 3: WHERE WERE THE REGULATORS? Contrary to the complaints you often hear from the financial industry, we have regulations for good reasons.

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Why did so many smart people believe these laissez-fairey tales? It’s a good question. Some of the blame surely goes to the excessive faith in free markets that was the elixir of the day. Some goes to economists who believed and extolled the efficient markets hypothesis—and taught it to their students, many of whom wound up as financial engineers on Wall Street. Another part almost certainly came from people’s collective tendency to forget the past. When times are good, asset values are rising, and loan defaults are rare, it is all too easy to forget one of the laws of financial gravity: What goes up too fast usually comes crashing down.

The Asian Financial Crisis 1995–98: Birth of the Age of Debt by Russell Napier

Alan Greenspan, Asian financial crisis, asset allocation, bank run, banking crisis, banks create money, Berlin Wall, book value, Bretton Woods, business cycle, Buy land – they’re not making it any more, capital controls, central bank independence, colonial rule, corporate governance, COVID-19, creative destruction, credit crunch, crony capitalism, currency manipulation / currency intervention, currency peg, currency risk, debt deflation, Deng Xiaoping, desegregation, discounted cash flows, diversification, Donald Trump, equity risk premium, financial engineering, financial innovation, floating exchange rates, Fractional reserve banking, full employment, Glass-Steagall Act, hindsight bias, Hyman Minsky, If something cannot go on forever, it will stop - Herbert Stein's Law, if you build it, they will come, impact investing, inflation targeting, interest rate swap, invisible hand, Japanese asset price bubble, Jeff Bezos, junk bonds, Kickstarter, laissez-faire capitalism, lateral thinking, Long Term Capital Management, low interest rates, market bubble, mass immigration, means of production, megaproject, Mexican peso crisis / tequila crisis, Michael Milken, Money creation, moral hazard, Myron Scholes, negative equity, offshore financial centre, open borders, open economy, Pearl River Delta, price mechanism, profit motive, quantitative easing, Ralph Waldo Emerson, regulatory arbitrage, rent-seeking, reserve currency, risk free rate, risk-adjusted returns, Ronald Reagan, Savings and loan crisis, savings glut, Scramble for Africa, short selling, social distancing, South China Sea, The Wealth of Nations by Adam Smith, too big to fail, yield curve

It was a form of capitalism that combined individualism with the aggressive use of balance sheet management for primarily personal profit. As early as 1983, Michael Milken was helping corporate America supercharge returns through the issuance of a record amount of speculative credit instruments known as junk bonds. The particular beneficiaries of this form of financial engineering were corporate management and incentives were soon put in place, primarily in the form of stock options, to incentivise such behaviour. The world has seen speculative corporate debt binges before, but this one was launched in a period when interest rates had just begun a decline that would last 40 years.

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John Maynard Keynes, The General Theory of Employment, Interest and Money, 1936 When the tide of capital turned it was indeed to be the asset traders and their financiers and their investors that lost most in this particular casino. That their collapse was to create a set of circumstances that would enfranchise the asset traders and their financiers to play this game on a global basis was something that I never considered. Rather than warn of the dangers of too much debt and financial engineering, the policy reactions to the Asian financial crisis set up the perfect environment for the asset traders and their financiers to ply their trade on an even grander scale. The “whirlpool of speculation” that was to follow dwarfed even the excesses of Asia and changed the world. Underwriting Hong Kong 20 November 1995, Hong Kong Last month, the heads of 30 Chinese state-owned firms in Hong Kong met in secret in Shenzhen, according to the latest Far Eastern Economic Review.

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However, where potentially large profits are involved there will always be someone tempted by the risk. In the mid-1990s, the cheap currency to borrow to fund such investment was the Japanese yen and this is the ‘excess liquidity’ I referred to in the piece from 30 July 1996. Japan was dealing with the consequences from the bursting of an asset-price bubble and the unwinding of the financial engineering – in Japanese, zaitech – that created not just low economic growth but solvency problems for the local financial system. The consequence was a steady decline in inflation and the BOJ was reducing interest rates in an attempt to bolster economic growth and reverse a recent deflation. For many investors the aggressive scale of this monetary response was likely to continue and as Japanese interest rates declined well below US interest rates, the yen was likely to fall relative to the US dollar.

In Pursuit of the Perfect Portfolio: The Stories, Voices, and Key Insights of the Pioneers Who Shaped the Way We Invest by Andrew W. Lo, Stephen R. Foerster

Alan Greenspan, Albert Einstein, AOL-Time Warner, asset allocation, backtesting, behavioural economics, Benoit Mandelbrot, Black Monday: stock market crash in 1987, Black-Scholes formula, Bretton Woods, Brownian motion, business cycle, buy and hold, capital asset pricing model, Charles Babbage, Charles Lindbergh, compound rate of return, corporate governance, COVID-19, credit crunch, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, Edward Glaeser, equity premium, equity risk premium, estate planning, Eugene Fama: efficient market hypothesis, fake news, family office, fear index, fiat currency, financial engineering, financial innovation, financial intermediation, fixed income, hiring and firing, Hyman Minsky, implied volatility, index fund, interest rate swap, Internet Archive, invention of the wheel, Isaac Newton, Jim Simons, John Bogle, John Meriwether, John von Neumann, joint-stock company, junk bonds, Kenneth Arrow, linear programming, Long Term Capital Management, loss aversion, Louis Bachelier, low interest rates, managed futures, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, money market fund, money: store of value / unit of account / medium of exchange, Myron Scholes, new economy, New Journalism, Own Your Own Home, passive investing, Paul Samuelson, Performance of Mutual Funds in the Period, prediction markets, price stability, profit maximization, quantitative trading / quantitative finance, RAND corporation, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, selection bias, seminal paper, shareholder value, Sharpe ratio, short selling, South Sea Bubble, stochastic process, stocks for the long run, survivorship bias, tail risk, Thales and the olive presses, Thales of Miletus, The Myth of the Rational Market, The Wisdom of Crowds, Thomas Bayes, time value of money, transaction costs, transfer pricing, tulip mania, Vanguard fund, yield curve, zero-coupon bond, zero-sum game

It seemed that Sharpe had reached the apex of his career. However, he remained active in his research. In 1996 he cofounded Financial Engines, a firm that pioneered independent online investment advice, with a focus on investing for retirement.62 “A colleague of mine in the law school, in securities, Joe Grundfest, who had been on the SEC [Securities Exchange Commission], and I were having coffee. He gave me a long song-and-dance about how if I really wanted to impact real people making these decisions, we needed to form a firm, etc. That was sort of how Financial Engines began. He introduced me to a fellow who was a lawyer, who also could help start firms, Craig Johnson.

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He introduced me to a fellow who was a lawyer, who also could help start firms, Craig Johnson. The three of us, basically, created Financial Engines. The goal was to help individual employees better use the 401(k) plans that were available to them for retirement savings. And, of course, the idea was to apply all the work that had been done in the academic finance field, which we set about doing.”63 Sharpe explained his interest in retirement planning and investing. “I and many others focused for many years on what we call the accumulation phase. You’re saving for your retirement. And while that was difficult, because it was a multiperiod problem en route, we could sort of take a shortcut and say, ‘Well, what you care about is the probability distribution of your wealth on the day you retire.’

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But they don’t all have to be just the market and something riskless. And third, we really don’t know what people’s preferences are.… You kind of need a multiperiod equilibrium model, not the one-period kind of CAPM, but that’s not horribly hard to get.”64 In addition to his practical work with Financial Engines, Sharpe continued to undertake innovative research. In 1992, he developed a simple approach to measuring fund performance that helped to “make order out of chaos” through what he called an asset-class factor model: attributing the overall return on a fund to the return on various stock and bond indices.65 He also produced a book based on his Princeton lectures on finance that reviewed his previous work and presented methods for analyzing security prices that accounted for investor behavior.66 If You Can’t Beat the Market, Join It Sharpe has three key messages that summarize the fundamental insights of the CAPM.

A First-Class Catastrophe: The Road to Black Monday, the Worst Day in Wall Street History by Diana B. Henriques

Alan Greenspan, asset allocation, bank run, banking crisis, Bear Stearns, behavioural economics, Bernie Madoff, Black Monday: stock market crash in 1987, break the buck, buttonwood tree, buy and hold, buy low sell high, call centre, Carl Icahn, centralized clearinghouse, computerized trading, Cornelius Vanderbilt, corporate governance, corporate raider, Credit Default Swap, cuban missile crisis, Dennis Tito, Edward Thorp, Elliott wave, financial deregulation, financial engineering, financial innovation, Flash crash, friendly fire, Glass-Steagall Act, index arbitrage, index fund, intangible asset, interest rate swap, It's morning again in America, junk bonds, laissez-faire capitalism, locking in a profit, Long Term Capital Management, margin call, Michael Milken, money market fund, Myron Scholes, plutocrats, Ponzi scheme, pre–internet, price stability, proprietary trading, quantitative trading / quantitative finance, random walk, Ronald Reagan, Savings and loan crisis, short selling, Silicon Valley, stock buybacks, The Chicago School, The Myth of the Rational Market, the payments system, tulip mania, uptick rule, Vanguard fund, web of trust

The university’s hillside campus had given birth to the Free Speech Movement, an influential protest against campus curbs on political activism, and Berkeley became a key organizing point for national antiwar marches and civil rights confrontations. By the 1970s, there was another buzz on campus, and it was occurring at the business school. Berkeley’s business school may not have had the wealth and prestige of Harvard’s or the free-market ferocity of the University of Chicago’s, but it was still at the forefront of a revolution in financial engineering. Less than fifty miles south of Berkeley, what would later be called Silicon Valley was producing computers that could analyze huge collections of numbers, such as the daily prices on America’s stock markets. The scholars at Berkeley and elsewhere who used such data to draw conclusions about the movements of the stock market became known as “quantitative” theorists, or “quants.”

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Without physical delivery, the price of a Dow futures contract could fall under or float above the real-world price of the Dow stocks on the NYSE. What would happen then? In the summer of 1981 the answer to that fateful question wasn’t clear—indeed, it wasn’t even considered. As it happened, the financial engineers in the futures markets had already figured out that cash settlement was the only way stock index futures could work for traders in their pits, and Johnson and his fellow CFTC commissioners were inclined to agree. The scene might have been funny if the consequences had not been so profound.

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It was even more remarkable that the brilliant people guiding those giant institutions did not realize that the markets—no, this single market—simply could not function if they all decided, at roughly the same time, to do the same thing with hundreds of billions of dollars. The Brady Report wasn’t about market prices; it was about market power—unprecedented market power, capable of derailing the financial engines of the country, and of any country. All that was required was for a significant portion of the world’s biggest and wealthiest investors to move in the same direction at the same time. The challenge was to build a market structure that could deal with this new reality, to weave America’s haphazard regulatory agencies into a single safety net and then somehow temper the power of the forces that could rip it apart.

Understanding Asset Allocation: An Intuitive Approach to Maximizing Your Portfolio by Victor A. Canto

accounting loophole / creative accounting, airline deregulation, Alan Greenspan, Andrei Shleifer, asset allocation, Bretton Woods, business cycle, buy and hold, buy low sell high, California energy crisis, capital asset pricing model, commodity trading advisor, corporate governance, discounted cash flows, diversification, diversified portfolio, equity risk premium, financial engineering, fixed income, frictionless, global macro, high net worth, index fund, inflation targeting, invisible hand, John Meriwether, junk bonds, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low cost airline, low interest rates, market bubble, merger arbitrage, money market fund, new economy, passive investing, Paul Samuelson, Performance of Mutual Funds in the Period, Phillips curve, price mechanism, purchasing power parity, risk free rate, risk tolerance, risk-adjusted returns, risk/return, rolling blackouts, Ronald Reagan, Savings and loan crisis, selection bias, seminal paper, shareholder value, Sharpe ratio, short selling, statistical arbitrage, stocks for the long run, survivorship bias, systematic bias, Tax Reform Act of 1986, the market place, transaction costs, Y2K, yield curve, zero-sum game

So, what we need to do now is enact a series of positive incentives that can eliminate the corporate manager’s desire to produce financially engineered results and replace it with the desire to pursue true economic profits. One simple way to move corporate officers and accountants in this direction is to require them to use only one set of accounting reports. I don’t care whether the reports are pro-forma or generally accepted accounting principles (GAAP). My view is whatever the investor is shown also should be shown to the IRS, with the appropriate taxes being paid thereafter. If CEOs cook the books to overstate their financially engineered profits, they pay higher taxes, making shareholders unhappy.

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For example, a financial manager would have an incentive to convert dividend returns into capital-gain returns if the tax on capital gains were reduced in a significant way. The incentive to do so would also generate some creative accounting behavior at the corporate level as well as an increase in resources devoted to the financial engineering of after-tax returns. • Altering the relative attractiveness of the way returns are delivered to investors also alters the investment composition of individual corporations. Changes in corporate and investor behavior are most likely noticeable during inflection points in the tax code. If tax-rate changes have the incentive effects I believe they do, the impact of the changes—in the form of behavioral shifts—should be visible to the naked eye.

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The reduction in the capital gains income tax in 1998 added to the corporate incentive to generate capital gains. The advantage of corporate debt over capital gains declined to $9.20 in 1998 from $21.50 in 1990 per $100 of pre-tax income (refer to Table 4.1). In turn, the capital gains advantage over dividends increased to $12.50 in 2000 from $2.00 in 1998. Earnings management and financial engineering became the biggest game in town. Just as in the junkbond 1980s, the changes at the beginning of this cycle were legitimate. But, as the easy pickings got arbitraged away, the game became a bit more complicated and the temptations for illegal behavior increased. The alternative to illegal behavior was often to suffer the investor’s wrath, so the incentive for creative bookkeeping was strong.

The New Tycoons: Inside the Trillion Dollar Private Equity Industry That Owns Everything by Jason Kelly

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, antiwork, barriers to entry, Bear Stearns, Berlin Wall, call centre, Carl Icahn, carried interest, collective bargaining, company town, corporate governance, corporate raider, Credit Default Swap, diversification, eat what you kill, Fall of the Berlin Wall, family office, financial engineering, fixed income, Goldman Sachs: Vampire Squid, Gordon Gekko, housing crisis, income inequality, junk bonds, Kevin Roose, late capitalism, margin call, Menlo Park, Michael Milken, military-industrial complex, Occupy movement, place-making, proprietary trading, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Rubik’s Cube, San Francisco homelessness, Sand Hill Road, Savings and loan crisis, shareholder value, side project, Silicon Valley, sovereign wealth fund, two and twenty

Firms can “exit” their investment by doing an initial public offering, a sale to another private-equity firm, or a sale to a corporation. Financial engineering: A term, usually used derisively, for the practice of buying a company with lots of debt, doing very little to the company itself, and selling it quickly for a profit. Private-equity firms increasingly tout their ability to make changes to the underlying business and its operations to prove they aren’t simply financial engineers. Fund: Private-equity firms collect discrete funds to make investments in a variety of companies. A firm typically manages a number of funds.

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That time period has seen the rise of “ops” as crucial to getting the money to generate the returns private-equity managers have promised their investors. Conklin and her ilk, many of whom are honest-to-goodness engineers, stand in contrast to the so-called financial engineers that earned private equity a nastier reputation. Financial engineering involves using leverage and creative balance sheet work to generate a return. With less debt available and higher prices, private-equity firms are focusing on actually changing companies’ businesses to make money. With rings and watches left back in the office, we grabbed clear safety glasses and disposable earplugs from a dispenser just inside the door to the factory.

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Jordan made an exception in 1988 when he saw that he needed to do something radically different with the business. There was a limited number of things to buy and growing competition. The returns he and his handful of competitors had achieved weren’t going to last on this business model. “The whole industry was financial engineering,” Jordan said. “I always thought the music would stop.” He called his former roommate at Notre Dame, Thomas Quinn, who at the time was an executive at the health care company Baxter International. Jordan convinced him to join the firm to run a new unit, the operations management group, or OMG.

The Rise of the Quants: Marschak, Sharpe, Black, Scholes and Merton by Colin Read

Abraham Wald, Albert Einstein, Bayesian statistics, Bear Stearns, Black-Scholes formula, Bretton Woods, Brownian motion, business cycle, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, discovery of penicillin, discrete time, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, fixed income, floating exchange rates, full employment, Henri Poincaré, implied volatility, index fund, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market clearing, martingale, means of production, moral hazard, Myron Scholes, Paul Samuelson, price stability, principal–agent problem, quantitative trading / quantitative finance, RAND corporation, random walk, risk free rate, risk tolerance, risk/return, Robert Solow, Ronald Reagan, shareholder value, Sharpe ratio, short selling, stochastic process, Thales and the olive presses, Thales of Miletus, The Chicago School, the scientific method, too big to fail, transaction costs, tulip mania, Works Progress Administration, yield curve

While he continues to serve on the advisory boards of the Financial Analysts Journal and the Journal of Investment Management, and has taught courses at Columbia University and the University of Southern California, he had devoted much of his career to the corporate sector. Over his career, he has amassed more than 70 directorships, trusteeships, and general partnerships. Treynor’s dedication to the fluid integration between theory and practice won him the International Association of Financial Engineers (IAFE) award as the 2007 IAFE/SunGard Financial Engineer of the Year (FEOY). This award is in recognition of his contributions to the CAPM. Treynor remains President of Treynor Capital Management and lives in Palos Verdes Estates, California. He turned 81 in 2011. In addition to his legacy as one of the originators of the CAPM, Treynor inspired another Nobel Laureate in a way remarkably similar to the inspiration that Harry Markowitz offered William Sharpe.

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He received the 1983 Leo Melamed Prize from the University of Chicago and the 1989 Distinguished Scholar Award from the Eastern Finance Association. He twice received the first prize from the Institute of Quantitative Research in Finance’s Roger Murray Award and a 1993 International INA-Academia Nazionale dei Lincei Prize from Italy’s National Academy of Lincei. He also earned the Financial Engineer of the Year Award from the International Association of Financial Engineers and the FORCE Award for Financial Innovation from Duke University. He was inducted into the Derivatives Hall of Fame by Derivatives Strategy in 1998. Merton also earned the Michael I. Pupin Medal for Service to the Nation from Columba University in 1998, the Distinguished Alumni Award from the California Institute of Technology, and the Mathematical Finance Day Lifetime Achievement Award from Boston University in 1999.

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For instance, he produced a discrete-time binomial option pricing procedure that offered a readily applicable procedure for BlackScholes securities pricing, which will be covered in the next part of this book. He also developed the Sharpe ratio, a measure of the risk of a mutual or index fund versus its reward. Sharpe continued to work to make financial concepts more democratic and more accessible. He helped develop Financial Engines, an Internetbased application to deliver investment advice online. 78 The Rise of the Quants Ever concerned about the practitioner’s side of finance, Sharpe began to consult with investment houses, first Merrill Lynch and then Wells Fargo. At Merrill Lynch, he helped set up their CAPM analysis capacity.

Valuation: Measuring and Managing the Value of Companies by Tim Koller, McKinsey, Company Inc., Marc Goedhart, David Wessels, Barbara Schwimmer, Franziska Manoury

accelerated depreciation, activist fund / activist shareholder / activist investor, air freight, ASML, barriers to entry, Basel III, Black Monday: stock market crash in 1987, book value, BRICs, business climate, business cycle, business process, capital asset pricing model, capital controls, Chuck Templeton: OpenTable:, cloud computing, commoditize, compound rate of return, conceptual framework, corporate governance, corporate social responsibility, creative destruction, credit crunch, Credit Default Swap, currency risk, discounted cash flows, distributed generation, diversified portfolio, Dutch auction, energy security, equity premium, equity risk premium, financial engineering, fixed income, index fund, intangible asset, iterative process, Long Term Capital Management, low interest rates, market bubble, market friction, Myron Scholes, negative equity, new economy, p-value, performance metric, Ponzi scheme, price anchoring, proprietary trading, purchasing power parity, quantitative easing, risk free rate, risk/return, Robert Shiller, Savings and loan crisis, shareholder value, six sigma, sovereign wealth fund, speech recognition, stocks for the long run, survivorship bias, technology bubble, time value of money, too big to fail, transaction costs, transfer pricing, two and twenty, value at risk, yield curve, zero-coupon bond

Our alternative approach is simple: if you can’t point to specific sources of increased cash flow, the stock market won’t be fooled. Financial engineering Another area where the value conservation principle is important is financial engineering, which unfortunately has no standard definition. For our purposes, we define financial engineering as the use of financial instruments or structures other than straight debt and equity to manage a company’s capital structure and risk profile. Financial engineering can include the use of derivatives, structured debt, securitization, and off-balance-sheet financing. While some of these activities can create real value, most don’t.

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In general, capital markets typically do a good job of pricing financial instruments, and companies will have difficulty boosting their share prices by accessing so-called cheap funding, however complex the funding structures are. Nevertheless, financial engineering can create shareholder value under specific conditions, both directly (through tax savings or lower costs of funding) and indirectly (for example, by increasing a company’s debt capacity so it can raise funds to capture more value-creating investment opportunities). However, such benefits need to outweigh any potential unintended consequences that inevitably arise with the complexity of financial engineering. This section considers three of the more common tools of financial engineering: derivative instruments that transfer company risks to third parties, off-balance-sheet financing that detaches funding from the company’s credit risk, and hybrid financing that offers new risk/return financing combinations.

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For example, when the Swiss-Swedish engineering company ABB announced a €775 million bond buyback in July 2004, its share price increased 4 percent on the day of the announcement. The stock market apparently saw the buyback as further evidence that the company was on a trajectory to recover from an earlier financial crisis. CREATING VALUE FROM FINANCIAL ENGINEERING Financial engineering means different things to different people. We define it as managing a company’s capital structure with financial instruments beyond straight debt and equity. It typically involves more complex and sometimes 35 See, for example, W. Mikkelson and M. Partch, “Valuation Effects of Security Offerings and the Issuance Process,” Journal of Financial Economics 15, nos. 1/2 (1986): 31–60; and Smith, “Investment Banking and the Capital Acquisition Process.” 670 CAPITAL STRUCTURE, DIVIDENDS, AND SHARE REPURCHASES even exotic instruments such as synthetic leasing, mezzanine finance, securitization, commodity-linked debt, commodity and currency derivatives, and balance sheet insurance.

The Impulse Society: America in the Age of Instant Gratification by Paul Roberts

"Friedman doctrine" OR "shareholder theory", 2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, 3D printing, Abraham Maslow, accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, Affordable Care Act / Obamacare, Alan Greenspan, American Society of Civil Engineers: Report Card, AOL-Time Warner, asset allocation, business cycle, business process, carbon tax, Carl Icahn, Cass Sunstein, centre right, choice architecture, classic study, collateralized debt obligation, collective bargaining, computerized trading, corporate governance, corporate raider, corporate social responsibility, creative destruction, crony capitalism, David Brooks, delayed gratification, disruptive innovation, double helix, Evgeny Morozov, factory automation, financial deregulation, financial engineering, financial innovation, fixed income, Ford Model T, full employment, game design, Glass-Steagall Act, greed is good, If something cannot go on forever, it will stop - Herbert Stein's Law, impulse control, income inequality, inflation targeting, insecure affluence, invisible hand, It's morning again in America, job automation, John Markoff, Joseph Schumpeter, junk bonds, knowledge worker, late fees, Long Term Capital Management, loss aversion, low interest rates, low skilled workers, mass immigration, Michael Shellenberger, new economy, Nicholas Carr, obamacare, Occupy movement, oil shale / tar sands, performance metric, postindustrial economy, profit maximization, Report Card for America’s Infrastructure, reshoring, Richard Thaler, rising living standards, Robert Shiller, Rodney Brooks, Ronald Reagan, shareholder value, Silicon Valley, speech recognition, Steve Jobs, stock buybacks, technological determinism, technological solutionism, technoutopianism, Ted Nordhaus, the built environment, the long tail, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, total factor productivity, Tyler Cowen, Tyler Cowen: Great Stagnation, value engineering, Walter Mischel, winner-take-all economy

So we aren’t necessarily being antibusiness or antitechnology to be worried by the way business now reflexively applies technology to raise profits with almost no consideration for the broader consequences. Or to feel uneasy at the fact that more and more of our technological skills and resources—which once lifted all society and advanced very broad social goals (and which remain crucial to solving our looming challenges)—are now devoted to fields such as financial “engineering,” whose social costs are now painfully well known. It is instructive that both the United States and the United Kingdom, which once generated most of their profits in their manufacturing sectors, now get their biggest profits from the financial industry. Telling, too, that most of the excitement around Big Data comes, not from its potential to solve the very complex problems of our times (nor even its potential to be abused), but for the way it is already letting the marketplace move closer to the self, with more immersive games, more adaptive personal technologies—even, fittingly, eyeglasses that place the entire digital economy just centimeters from your brain.

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Nearly all companies tie their management directly to the financial markets with stock-based compensation. (By 2000, stock options had lifted the average CEO’s compensation to more than four hundred times that of the median employee, up from a ratio of twenty to one in the 1970s.36) Likewise, “financial engineering,” or the use of financial techniques, such as share buybacks, to raise share prices, is now a standard part of the corporate strategic repertoire. During the 1990s stock market boom, hundreds of companies used their own rapidly appreciating shares as a kind of übercurrency to go on acquisition sprees.

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Marriage continues to decline as partners now hold out the possibility for a better romantic return elsewhere. And of course the business world remains locked in the finance mind-set. The tenure of the average company CEO has fallen to five years, from nine two decades ago.49 Stock-based pay remains the norm, as does the strategy of share buybacks and other financial engineering. Lazonick has calculated that between 2001 and 2012, buybacks by the five hundred companies of the S&P 500 sucked up a stunning three and a half trillion dollars—roughly three-quarters as much as the U.S. government spent to win World War II.50 These are the classic symptoms of the Impulse Society—an economy so thoroughly reconfigured around the desire for rapid returns that it is increasingly incapable of producing what we need.

The Age of Stagnation: Why Perpetual Growth Is Unattainable and the Global Economy Is in Peril by Satyajit Das

"there is no alternative" (TINA), "World Economic Forum" Davos, 9 dash line, accounting loophole / creative accounting, additive manufacturing, Airbnb, Alan Greenspan, Albert Einstein, Alfred Russel Wallace, Anthropocene, Anton Chekhov, Asian financial crisis, banking crisis, Bear Stearns, Berlin Wall, bitcoin, bond market vigilante , Bretton Woods, BRICs, British Empire, business cycle, business process, business process outsourcing, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, carbon tax, Carmen Reinhart, Clayton Christensen, cloud computing, collaborative economy, colonial exploitation, computer age, creative destruction, cryptocurrency, currency manipulation / currency intervention, David Ricardo: comparative advantage, declining real wages, Deng Xiaoping, deskilling, digital divide, disintermediation, disruptive innovation, Downton Abbey, Emanuel Derman, energy security, energy transition, eurozone crisis, financial engineering, financial innovation, financial repression, forward guidance, Francis Fukuyama: the end of history, full employment, geopolitical risk, gig economy, Gini coefficient, global reserve currency, global supply chain, Goldman Sachs: Vampire Squid, Great Leap Forward, Greenspan put, happiness index / gross national happiness, high-speed rail, Honoré de Balzac, hydraulic fracturing, Hyman Minsky, illegal immigration, income inequality, income per capita, indoor plumbing, informal economy, Innovator's Dilemma, intangible asset, Intergovernmental Panel on Climate Change (IPCC), it is difficult to get a man to understand something, when his salary depends on his not understanding it, It's morning again in America, Jane Jacobs, John Maynard Keynes: technological unemployment, junk bonds, Kenneth Rogoff, Kevin Roose, knowledge economy, knowledge worker, Les Trente Glorieuses, light touch regulation, liquidity trap, Long Term Capital Management, low interest rates, low skilled workers, Lyft, Mahatma Gandhi, margin call, market design, Marshall McLuhan, Martin Wolf, middle-income trap, Mikhail Gorbachev, military-industrial complex, Minsky moment, mortgage debt, mortgage tax deduction, new economy, New Urbanism, offshore financial centre, oil shale / tar sands, oil shock, old age dependency ratio, open economy, PalmPilot, passive income, peak oil, peer-to-peer lending, pension reform, planned obsolescence, plutocrats, Ponzi scheme, Potemkin village, precariat, price stability, profit maximization, pushing on a string, quantitative easing, race to the bottom, Ralph Nader, Rana Plaza, rent control, rent-seeking, reserve currency, ride hailing / ride sharing, rising living standards, risk/return, Robert Gordon, Robert Solow, Ronald Reagan, Russell Brand, Satyajit Das, savings glut, secular stagnation, seigniorage, sharing economy, Silicon Valley, Simon Kuznets, Slavoj Žižek, South China Sea, sovereign wealth fund, Stephen Fry, systems thinking, TaskRabbit, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, the market place, the payments system, The Spirit Level, Thorstein Veblen, Tim Cook: Apple, too big to fail, total factor productivity, trade route, transaction costs, uber lyft, unpaid internship, Unsafe at Any Speed, Upton Sinclair, Washington Consensus, We are the 99%, WikiLeaks, Y2K, Yom Kippur War, zero-coupon bond, zero-sum game

But, as fund managers customarily state in their solicitations to invest, the past is no guarantee of future performance. Financial engineering continues to be used to mask the true performance and real position of enterprises and nations. To maintain or increase earnings in a difficult environment, businesses have re-engineered their structure and finances rather than their operations. They have merged with or acquired companies. Since 2009, US share buybacks totaling nearly US$2 trillion, frequently financed by low-cost debt, have boosted share prices and now make up an increasing proportion of the value of stocks traded. Since the crisis, governments too have resorted to financial engineering to deal with economic problems.

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The dominant figures were star mutual fund managers, who gained ascendancy over conservative investment professionals, aggressively chasing growth with rapid purchases and sales of stocks to take advantage of market momentum. In a pattern that was to be repeated in the 1980s, 1990s, and 2000s, the boom was driven by a mixture of glamorous technology stocks, speculation, and financial engineering. Conglomerates such as Ling-Temco-Vought, International Telephone & Telegraph, and Gulf & Western anticipated future private equity firms, buying and selling disparate businesses in sectors such as missiles, hotels, real estate, car rentals, golf equipment, and film studios. Low interest rates and cheap financing costs helped fuel the rapid increase in stock and asset prices.

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The range of financial instruments and services expanded; the sector became large relative to the size of the real economy, and a major contributor to growth. In previous eras, the creation, production, and sale of goods and services were the means to success. Now, the structuring and trading of financial products representing claims on businesses and underlying activities was the path to wealth. Financial engineering was to ultimately become more important than real engineering. Commencing in the 1980s, there was unprecedented expansion in cross-border trade and flow of capital. The large US deficits resulting from the Vietnam War and Great Society programs had created significant overseas holdings of US dollars.

Nothing But Net by Mark Mahaney

Airbnb, AltaVista, Amazon Web Services, AOL-Time Warner, augmented reality, autonomous vehicles, Big Tech, Black Swan, Burning Man, buy and hold, Cambridge Analytica, Chuck Templeton: OpenTable:, cloud computing, COVID-19, cryptocurrency, discounted cash flows, disintermediation, diversification, don't be evil, Donald Trump, Elon Musk, financial engineering, gamification, gig economy, global pandemic, Google Glasses, Jeff Bezos, John Zimmer (Lyft cofounder), knowledge economy, lockdown, low interest rates, Lyft, Marc Andreessen, Mark Zuckerberg, Mary Meeker, medical malpractice, meme stock, Network effects, PageRank, pets.com, ride hailing / ride sharing, Salesforce, Saturday Night Live, shareholder value, short squeeze, Silicon Valley, Skype, Snapchat, social graph, Steve Jobs, stocks for the long run, subscription business, super pumped, the rule of 72, TikTok, Travis Kalanick, Uber and Lyft, uber lyft

Simplistically, there are three ways companies can generate earnings: grow revenue, reduce operating costs, or engage in “financial engineering.” And by “financial engineering,” I mean things like selling loss-generating assets, reducing tax rates through a shuffling of profits toward lower-tax locations, generating one-time gains by selling investment stakes, sharing buybacks, better positioning the cash and equivalents on a company’s balance sheet to generate higher investment income, and the like. Maybe this is the realization of the simple maxim “The greater the effort, the greater the return.” “Financial engineering” is easy. There are armies of consultants who can help a company better execute on tax and asset strategies.

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But when it’s an appropriate time for a company to do take these steps, well, that’s the exact time a tech investor may not want to be around. One of the earnings growth strategies that I didn’t mention above, but is used quite often, is M&A or acquisitions. I would still put this in the “financial engineering” camp, though I realize that is clearly cheapening the term. As a rule, I would argue that organic revenue growth—driven by increased unit sales, new product offerings, geographic market expansion, or price increases—is more impressive and should be worth more to tech investors than acquired growth.

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Usually, so does the P/S ratio (the price-to-sales ratio). Depending on the driver of that earnings growth acceleration, the multiple can re-rate a little or a lot. This ties back to the prior discussion of the three ways of driving earnings: growing revenue, reducing operating costs, or engaging in “financial engineering.” The market will be most impressed by an earnings growth acceleration that is driven by accelerating revenue growth, because that is the hardest of the three ways. And what drives accelerating revenue growth is GCIs. So what are GCIs? These are steps that companies take to drive new top-line growth.

Financial Statement Analysis: A Practitioner's Guide by Martin S. Fridson, Fernando Alvarez

Bear Stearns, book value, business cycle, corporate governance, credit crunch, discounted cash flows, diversification, Donald Trump, double entry bookkeeping, Elon Musk, financial engineering, fixed income, information trail, intangible asset, interest rate derivative, interest rate swap, junk bonds, negative equity, new economy, offshore financial centre, postindustrial economy, profit maximization, profit motive, Richard Thaler, shareholder value, speech recognition, statistical model, stock buybacks, the long tail, time value of money, transaction costs, Y2K, zero-coupon bond

With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers' professional and personal knowledge and understanding. The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation and financial instrument analysis, as well as much more. For a list of available titles, visit our Web site at www.WileyFinance.com. Copyright © 2011 by Martin Fridson and Fernando Alvarez. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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By acquiring the smaller company at a price of 12 times earnings with stock valued at a multiple of 14 times, Big Time spreads Small Change's earnings across fewer shares than would be the case if the market valued the two companies at the same multiple. The effect, achieved purely through financial engineering, is a parody of the economies of scale realized in mergers premised instead of improvements in operations. In fairness to the many real-world companies that have exploited disparities in price-earnings multiples over the years, Big Time's share-price-enhancing acquisition rests squarely within the bounds of fair play.

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Over the years, many voracious acquirers have temporarily achieved stratospheric multiples on their acquisition currency through financial reporting gimmicks that hard-nosed analysts were able to detect before the share prices fell back to earth. In some instances, the basis for an exaggerated P/E multiple is rapid earnings per share (EPS) growth achieved through financial engineering rather than bona fide synergies. Starting with a modest multiple on its stock, a company can make a few small acquisitions of low-multiple companies to get the earnings acceleration started. Each transaction may be too small to be deemed material in itself. That would eliminate any obligation on the company's part to divulge details that would make it easy for analysts to quantify the impact of the company's exploitation of disparities in P/E multiples.

For Profit: A History of Corporations by William Magnuson

"Friedman doctrine" OR "shareholder theory", activist fund / activist shareholder / activist investor, Airbnb, bank run, banks create money, barriers to entry, Bear Stearns, Big Tech, Black Lives Matter, blockchain, Bonfire of the Vanities, bread and circuses, buy low sell high, carbon tax, carried interest, collective bargaining, Cornelius Vanderbilt, corporate raider, creative destruction, disinformation, Donald Trump, double entry bookkeeping, Exxon Valdez, fake news, financial engineering, financial innovation, Ford Model T, Ford paid five dollars a day, Frederick Winslow Taylor, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Ida Tarbell, Intergovernmental Panel on Climate Change (IPCC), invisible hand, joint-stock company, joint-stock limited liability company, junk bonds, Mark Zuckerberg, Menlo Park, Michael Milken, move fast and break things, Peter Thiel, power law, price discrimination, profit maximization, profit motive, race to the bottom, Ralph Waldo Emerson, randomized controlled trial, ride hailing / ride sharing, scientific management, Sheryl Sandberg, Silicon Valley, Silicon Valley startup, slashdot, Snapchat, South Sea Bubble, spice trade, Steven Levy, The Wealth of Nations by Adam Smith, Thomas L Friedman, Tim Cook: Apple, too big to fail, trade route, transcontinental railway, union organizing, work culture , Y Combinator, Yom Kippur War, zero-sum game

This belief pervades not just society but also the leaders of corporations themselves. It has tended to make business leaders less reflective about society’s great problems and more intensely focused on extracting profit. It has contributed to the growth of financial capitalism, a species of corporate activity devoted to financial engineering rather than material production. It has also promoted the “move fast and break things” ethos of Silicon Valley, which values rapid technological growth over responsible behavior. And while corporate leaders occasionally pay lip service to their role as guardians of the public interest, with a few notable exceptions they appear less and less convinced of it.

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Though the Medici didn’t invent double-entry bookkeeping—other Florentine banks of the time also used the method, and there is evidence of its use in Genoa as early as 1340—they perfected the art. The bank’s accounting records were so comprehensive that we are still able to reconstruct with pinpoint accuracy the profits and losses made by individual branches in individual years for most of the bank’s existence. It is a remarkable testament to the Medici Bank’s fine-tuned system of financial engineering. GIOVANNI KNEW THAT ALL OF HIS COMPLEX SCHEMES AND STRUCTURES would mean nothing if his bank did not have customers. And so, from the very beginning, he went to work cultivating them. His first stop was the church, and he gambled big on it. In the late 1390s, a young Neapolitan archdeacon named Baldassare Cossa was making a name for himself within the Vatican.

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Foster, a Pittsburgh drilling-equipment company, for $106 million; twelve years later, investors received back six times their money. US Natural Resources, an Oregon-based coal-machinery company, sold to KKR for $22 million; seven years later, investors would receive back twenty times their money. With a few deals under their belts, Kohlberg, Kravis, and Roberts could tell that they were onto something. And if their financial engineering worked for these small companies, wouldn’t it work for bigger ones too? The trio thought it would. But in order to target bigger fish, they needed more investments—and bigger ones. So, in 1978 they went out and raised a buyout fund. Now that they had a slightly longer track record, they could target the institutional investors who had passed on their offers the first time around.

Keeping at It: The Quest for Sound Money and Good Government by Paul Volcker, Christine Harper

Alan Greenspan, anti-communist, Ayatollah Khomeini, banking crisis, Bear Stearns, behavioural economics, Black Monday: stock market crash in 1987, Bretton Woods, business cycle, central bank independence, corporate governance, Credit Default Swap, Donald Trump, fiat currency, financial engineering, financial innovation, fixed income, floating exchange rates, forensic accounting, full employment, Glass-Steagall Act, global reserve currency, income per capita, inflation targeting, liquidationism / Banker’s doctrine / the Treasury view, low interest rates, margin call, money market fund, Nixon shock, oil-for-food scandal, Paul Samuelson, price stability, proprietary trading, quantitative easing, reserve currency, Right to Buy, risk-adjusted returns, Ronald Reagan, Rosa Parks, Savings and loan crisis, secular stagnation, Sharpe ratio, Silicon Valley, special drawing rights, too big to fail, traveling salesman, urban planning

I found myself sitting in the audience next to William Sharpe, a 1990 Nobel laureate in economics whose “Sharpe ratio” has become a widely accepted measure of risk-adjusted returns for fund managers. I nudged him and asked how much this new financial engineering contributed to economic growth, measured by GNP. “Nothing,” he whispered back to me. It was not the answer I anticipated. “So what does it do?” was my response. “It just moves around the [economic] rents* in the financial system. Besides it’s a lot of fun.” (Later, at dinner, he suggested the possibility of small ways in which economic welfare could be advanced, but I felt I had already gotten the gist of his thinking.) One aspect of financial engineering soon took off. Credit default swaps, originally designed to provide banks with an efficient way to insure their own loan portfolios, proliferated as trading instruments.

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Training graduates in the arguably more mundane tasks of effective administration doesn’t fit their definition of an academic discipline. The irony for me is that there is today far more practical training at Princeton and elsewhere than when I was a student. The training is in the engineering school, considered a second rate option in my day but now richly rewarded for turning out new financial engineers and data wizards for Wall Street and Silicon Valley. That’s where the money is and that’s where the talent flows, including two of my grandsons. The point was driven home to me one evening when, by chance, I was walking with a young economics professor toward the Woodrow Wilson School. I idly remarked that “this university doesn’t pay enough attention to public administration.”

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Jim Leach was only partly successful in making sure the legislation maintained the Fed’s primary role as the overseer of the entire bank holding company. (A decade later, in the wake of the financial crisis, he ruefully told me that his support for repeal of Glass-Steagall had been a mistake.) The World of Derivatives I cannot claim expertise, or even close familiarity, with the rapid development and application of “financial engineering.” Along with other members of my generation, I was struck a couple of decades ago by the enthusiastic presentation of a young London investment banker to a high-level business conference at the Villa d’Este in Lake Como, Italy. He concluded with a strong warning: businesses, particularly financial businesses, that were not fully aware of and capable of using the new instruments of finance would be doomed to failure.

The Theft of a Decade: How the Baby Boomers Stole the Millennials' Economic Future by Joseph C. Sternberg

Affordable Care Act / Obamacare, Airbnb, Alan Greenspan, American Legislative Exchange Council, Asian financial crisis, banking crisis, Basel III, Bear Stearns, Bernie Sanders, blue-collar work, centre right, corporate raider, Detroit bankruptcy, Donald Trump, Edward Glaeser, employer provided health coverage, Erik Brynjolfsson, eurozone crisis, financial engineering, future of work, gig economy, Gordon Gekko, hiring and firing, Home mortgage interest deduction, housing crisis, independent contractor, job satisfaction, job-hopping, labor-force participation, low interest rates, low skilled workers, Lyft, Marc Andreessen, Mark Zuckerberg, minimum wage unemployment, mortgage debt, mortgage tax deduction, Nate Silver, new economy, obamacare, oil shock, payday loans, pension reform, quantitative easing, Richard Florida, Ronald Reagan, Saturday Night Live, Second Machine Age, sharing economy, Silicon Valley, sovereign wealth fund, Steve Bannon, stop buying avocado toast, TaskRabbit, total factor productivity, Tyler Cowen, Tyler Cowen: Great Stagnation, uber lyft, unpaid internship, women in the workforce

Despite a bumper year in 1983 as the economy roared back from its recessionary malaise, fixed investment grew by an average of only 4.1 percent per year between 1983 and 1990—higher than the doldrums of the late 1970s and early ’80s, to be sure, but far off America’s mid-century investment peak. Output per hour worked grew a relatively sluggish 1.9 percent per year during this span.18 Instead, falling borrowing costs, as America emerged from the stagflationary 1970s and the high interest rates of the early 1980s, and low taxation on capital created a new boom in financial engineering: leveraged buy-outs, mergers and acquisitions, and other Gordon Gekko–like techniques. The basic principle was that companies would use cheap credit to borrow heavily against their assets and expected future revenue and then use the money either to buy other companies or to buy back the company’s own stock.

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The only difference was that the gap widened a little after a 1997 tax reform pushed by a Republican Congress cut the top capital gains tax rate to 20 percent, while the top corporate income rate stayed at 35 percent. And if anything, the regulatory thicket that discouraged productive investment compared to financial engineering got worse in the 1990s, despite the Clinton administration’s “Reinventing Government” gimmick. Labor regulations such as the new Family and Medical Leave Act and new standards on indoor air quality—plus an expansion of the scope of earlier labor rules to encompass more small companies—raised the cost of employing human beings, indirectly discouraging capital investments that would require more workers to pay off.

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Bush years again saw ultralow interest rates—the federal funds rate sat well below 2 percent for most of Bush’s first term, ostensibly to help the economy recover from the dual shocks of the dot-com bust and the September 11 terror attacks—and again saw reductions in capital gains taxes relative to other forms of taxation, with the top capital gains rate falling to 15 percent, while the top corporate-income rate remained stuck at 35 percent. Financial engineering exploded again.* Fixed investment hit a blistering 5.4 percent growth rate during the five years of Bush’s two terms when it grew, excluding the tail of the dot-com recession in his first year and the downturn in investment that presaged the financial crisis starting in 2007.26 But the growth rate in output per hour worked was starting to drift downward again from its 1990s peak (which already had failed to match the mid-twentieth-century boom), hitting an average of 1.9 percent per year in Bush’s first seven years.27 The big boom was not in productivity but in housing—one of the less productive sectors of the economy, since once a house is built, it contributes only weakly to output growth.

Chaos Kings: How Wall Street Traders Make Billions in the New Age of Crisis by Scott Patterson

"World Economic Forum" Davos, 2021 United States Capitol attack, 4chan, Alan Greenspan, Albert Einstein, asset allocation, backtesting, Bear Stearns, beat the dealer, behavioural economics, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, bitcoin, Bitcoin "FTX", Black Lives Matter, Black Monday: stock market crash in 1987, Black Swan, Black Swan Protection Protocol, Black-Scholes formula, blockchain, Bob Litterman, Boris Johnson, Brownian motion, butterfly effect, carbon footprint, carbon tax, Carl Icahn, centre right, clean tech, clean water, collapse of Lehman Brothers, Colonization of Mars, commodity super cycle, complexity theory, contact tracing, coronavirus, correlation does not imply causation, COVID-19, Credit Default Swap, cryptocurrency, Daniel Kahneman / Amos Tversky, decarbonisation, disinformation, diversification, Donald Trump, Doomsday Clock, Edward Lloyd's coffeehouse, effective altruism, Elliott wave, Elon Musk, energy transition, Eugene Fama: efficient market hypothesis, Extinction Rebellion, fear index, financial engineering, fixed income, Flash crash, Gail Bradbrook, George Floyd, global pandemic, global supply chain, Gordon Gekko, Greenspan put, Greta Thunberg, hindsight bias, index fund, interest rate derivative, Intergovernmental Panel on Climate Change (IPCC), Jeff Bezos, Jeffrey Epstein, Joan Didion, John von Neumann, junk bonds, Just-in-time delivery, lockdown, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, Mark Spitznagel, Mark Zuckerberg, market fundamentalism, mass immigration, megacity, Mikhail Gorbachev, Mohammed Bouazizi, money market fund, moral hazard, Murray Gell-Mann, Nick Bostrom, off-the-grid, panic early, Pershing Square Capital Management, Peter Singer: altruism, Ponzi scheme, power law, precautionary principle, prediction markets, proprietary trading, public intellectual, QAnon, quantitative easing, quantitative hedge fund, quantitative trading / quantitative finance, Ralph Nader, Ralph Nelson Elliott, random walk, Renaissance Technologies, rewilding, Richard Thaler, risk/return, road to serfdom, Ronald Reagan, Ronald Reagan: Tear down this wall, Rory Sutherland, Rupert Read, Sam Bankman-Fried, Silicon Valley, six sigma, smart contracts, social distancing, sovereign wealth fund, statistical arbitrage, statistical model, stem cell, Stephen Hawking, Steve Jobs, Steven Pinker, Stewart Brand, systematic trading, tail risk, technoutopianism, The Chicago School, The Great Moderation, the scientific method, too big to fail, transaction costs, University of East Anglia, value at risk, Vanguard fund, We are as Gods, Whole Earth Catalog

Published in 1996, it was the culmination of more than a decade of research and hard-won experience on the trading floor. In an interview that year for the trade journal Derivatives Strategy titled “The World According to Nassim Taleb,” he attacked the heavy reliance on math in the chaotic world of Wall Street, which had come to be known as financial engineering to give it a patina of a hard science. “What problems do you have with financial engineering?” the interviewer asked. “Some folks looked at the literature and saw differential equations and said, ‘Gee it’s like engineering,’ ” Taleb said. “Engineering relies on models because you can capture the relationships in the physical world very well.

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They could sleep at night. In a post-crash letter to Universa investors, Spitznagel wrote that “going forward, there is every good reason to expect that protecting against large drawdowns with Universa should remain the superior risk mitigation strategy, saving you the needless costs and risks associated with most financial engineering and Modern Finance solutions, while providing superior ‘crash-bang-for-the-buck’ should the crash continue.” Universa’s 2020 bonanza had been decades in the making. By the late 2000s, it was managing positions to protect billions of dollars against outsize losses, making Spitznagel extremely rich indeed.

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Financial markets, and the economies that depend on them, have become increasingly complex, unstable, and prone to crashes. In the early 2000s, economists such as Ben Bernanke, who would later become chairman of the Federal Reserve, claimed that the global economy had entered a so-called Great Moderation. The steady hand of economic technicians, the spread of derivatives and other products of Wall Street’s financial engineers (the quants), and low inflation meant the world was set to enjoy untold prosperity, the gift of not-too-hot-not-too-cold, centrally managed perpetual growth. Then came 2008, when the collapse of the U.S. subprime mortgage market ignited a global economic panic attack. The loss of a few hundred billion dollars in mortgages spread like a contagion through derivatives markets, leading to trillions in losses.

Derivatives Markets by David Goldenberg

Black-Scholes formula, Brownian motion, capital asset pricing model, commodity trading advisor, compound rate of return, conceptual framework, correlation coefficient, Credit Default Swap, discounted cash flows, discrete time, diversification, diversified portfolio, en.wikipedia.org, financial engineering, financial innovation, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, law of one price, locking in a profit, London Interbank Offered Rate, Louis Bachelier, margin call, market microstructure, martingale, Myron Scholes, Norbert Wiener, Paul Samuelson, price mechanism, random walk, reserve currency, risk free rate, risk/return, riskless arbitrage, Sharpe ratio, short selling, stochastic process, stochastic volatility, time value of money, transaction costs, volatility smile, Wiener process, yield curve, zero-coupon bond, zero-sum game

To summarize, the payoff to the difference between a long spot position and a long forward position is exactly the same as the payoff to a long position in a zero-coupon bond with face value equal to the forward price, and maturing at the same time as the forward contract. In the language of financial engineering, we have replicated the payoff to the original (natural) difference strategy by a synthetic strategy which is simply to buy the appropriate zero-coupon bond. Buy because we need to generate a positive cash flow equal to +Ft,T at time T. A basic principle of finance (the no-arbitrage principle, or the law of one price) is that if you can do what we just did, then the current costs of the two strategies must be the same.

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This hedges against the risk of rising variable rates, but it creates another hedging problem which we will discuss under the section that describes how the swaps dealer finds a counterparty firm AAA. We confine our attention to BBB issuing variable-rate financing. Of course, this won’t make BBB happy, because BBB wants fixed-rate financing. As financial engineers, we are going to give BBB fixed-rate financing. The only thing is that it will be synthetic fixed-rate financing, as opposed to the natural fixed-rate financing available to it in the fixed-rate bond market. Synthetic fixed-rate financing is a product structured from variable-rate financing in combination with a swap.

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These options can be viewed as the most fundamental derivative securities because they serve as the building blocks for constructing other derivative securities, including forward contracts and swaps. Synthesizing and pricing complex derivative securities from simpler, relatively well-known financial instruments such as stocks, bonds, and plain vanilla options is the subject of financial engineering. Options are important to both professionals and the average investor because they appear in many different financial scenarios that investors will routinely encounter. Most investors are familiar with ordinary securities like stocks and bonds. The stock market is constantly in the limelight.

Frequently Asked Questions in Quantitative Finance by Paul Wilmott

Abraham Wald, Albert Einstein, asset allocation, beat the dealer, Black-Scholes formula, Brownian motion, butterfly effect, buy and hold, capital asset pricing model, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, delta neutral, discrete time, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial engineering, fixed income, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, iterative process, lateral thinking, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, martingale, Myron Scholes, Norbert Wiener, Paul Samuelson, power law, quantitative trading / quantitative finance, random walk, regulatory arbitrage, risk free rate, risk/return, Sharpe ratio, statistical arbitrage, statistical model, stochastic process, stochastic volatility, transaction costs, urban planning, value at risk, volatility arbitrage, volatility smile, Wiener process, yield curve, zero-coupon bond

Based on proven techniques that have been tested time and again, this comprehensive resource provides readers with the knowledge and guidance to effectively use credit derivatives pricing models. Principles of Financial Engineering by Salih Neftci “This is the first comprehensive hands-on introduction to financial engineering. Neftci is enjoyable to read, and finds a natural balance between theory and practice.” Darrell Duffie Publisher Academic Press Publication date 2004 Format Hardback ISBN 0125153945 On a topic where there is already a substantial body of literature, Salih Neftci succeeds in presenting a fresh, original, informative, and up-to-date introduction to financial engineering. The book offers clear links between intuition and underlying mathematics and an outstanding mixture of market insights and mathematical materials.

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References and Further Reading Chapter 3 - The Most Popular Probability Distributions and Their Uses in Finance References and further reading Chapter 4 - Ten Different Ways to Derive Black-Scholes Hedging and the Partial Differential Equation Martingales Change of Numeraire Local Time Parameters as Variables Continuous-time Limit of the Binomial Model CAPM Utility Theory A Diffusion Equation Black-Scholes for Accountants References and Further Reading Chapter 5 - Models and Equations Equity, Foreign Exchange and Commodities Fixed Income Credit References and Further Reading Chapter 6 - The Black-Scholes Formulæ and the Greeks Chapter 7 - Common Contracts Things to Look Out for in Exotic Contracts Examples Chapter 8 - Popular Quant Books Paul Wilmott Introduces Quantitative Finance by Paul Wilmott Paul Wilmott On Quantitative Finance by Paul Wilmott Advanced Modelling in Finance Using Excel and VBA by Mary Jackson and Mike Staunton Option Valuation under Stochastic Volatility by Alan Lewis The Concepts and Practice of Mathematical Finance by Mark Joshi C++ Design Patterns and Derivatives Pricing by Mark Joshi Heard on the Street by Timothy Crack Monte Carlo Methods in Finance by Peter Jäckel Credit Derivatives Pricing Models by Philipp Schönbucher Principles of Financial Engineering by Salih Neftci Options, Futures, and Other Derivatives by John Hull The Complete Guide to Option Pricing Formulas by Espen Gaarder Haug Chapter 9 - The Most Popular Search Words and Phrases on Wilmott.com Chapter 10 - Brainteasers The Questions The Answers Chapter 11 - Paul & Dominic’s Guide to Getting a Quant Job Introduction Writing a CV Interviews Appearance What People Get Wrong More Copyright © 2007 Paul Wilmott.

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Whether you use Monte Carlo for probabilistic or deterministic problems the method is usually quite simple to implement in basic form and so is extremely popular in practice. References and Further Reading Boyle, P 1977 Options: a Monte Carlo approach. Journal of Financial Economics 4 323-338 Glasserman, P 2003 Monte Carlo Methods in Financial Engineering . Springer Verlag Jäckel, P 2002 Monte Carlo Methods in Finance. John Wiley & Sons What is the Finite-difference Method? Short Answer The finite-difference method is a way of approximating differential equations, in continuous variables, into difference equations, in discrete variables, so that they may be solved numerically.

Other People's Money: Masters of the Universe or Servants of the People? by John Kay

Affordable Care Act / Obamacare, Alan Greenspan, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, behavioural economics, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Monday: stock market crash in 1987, Black Swan, Bonfire of the Vanities, bonus culture, book value, Bretton Woods, buy and hold, call centre, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, cognitive dissonance, Cornelius Vanderbilt, corporate governance, Credit Default Swap, cross-subsidies, currency risk, dematerialisation, disinformation, disruptive innovation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, Elon Musk, Eugene Fama: efficient market hypothesis, eurozone crisis, financial engineering, financial innovation, financial intermediation, financial thriller, fixed income, Flash crash, forward guidance, Fractional reserve banking, full employment, George Akerlof, German hyperinflation, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Greenspan put, Growth in a Time of Debt, Ida Tarbell, income inequality, index fund, inflation targeting, information asymmetry, intangible asset, interest rate derivative, interest rate swap, invention of the wheel, Irish property bubble, Isaac Newton, it is difficult to get a man to understand something, when his salary depends on his not understanding it, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", Jim Simons, John Meriwether, junk bonds, light touch regulation, London Whale, Long Term Capital Management, loose coupling, low cost airline, M-Pesa, market design, Mary Meeker, megaproject, Michael Milken, millennium bug, mittelstand, Money creation, money market fund, moral hazard, mortgage debt, Myron Scholes, NetJets, new economy, Nick Leeson, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shock, passive investing, Paul Samuelson, Paul Volcker talking about ATMs, peer-to-peer lending, performance metric, Peter Thiel, Piper Alpha, Ponzi scheme, price mechanism, proprietary trading, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, random walk, reality distortion field, regulatory arbitrage, Renaissance Technologies, rent control, risk free rate, risk tolerance, road to serfdom, Robert Shiller, Ronald Reagan, Schrödinger's Cat, seminal paper, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, sovereign wealth fund, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, Steve Wozniak, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tobin tax, too big to fail, transaction costs, tulip mania, Upton Sinclair, Vanguard fund, vertical integration, Washington Consensus, We are the 99%, Yom Kippur War

The company is awash with cash, but much of that money is overseas, and there would be a tax charge if it were repatriated to the USA. For many other companies, the tax-favoured status of debt relative to equity encourages financial engineering. Most large multinational companies have corporate and financial structures of mind-blowing complexity. The mechanics of these arrangements, which are mainly directed at tax avoidance or regulatory arbitrage, are understood by only a handful of specialists. Much of the securities issuance undertaken by Goldman Sachs was not ‘helping companies to grow’ but represented financial engineering of the kind undertaken at Apple. What does this capital market activity have to do with business – to return to the question Burrough and Helyar raised?

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The bonus culture in both financial and non-financial sectors, far from aligning the interests of managers and traders with those of shareholders, produced an outcome in which the objectives of managers and traders were materially different from those of the organisations for which they worked. This agency problem – companies being run for the benefit of a group of senior employees – was most acute in the financial sector but also infected the corporate sector more widely. The very large fees paid to investment bankers for their role in facilitating deals and financial engineering were another aspect of this agency problem. Managers were spending other people’s money, with the profusion and negligence that Adam Smith had anticipated. The extension of Smith’s agency problem throughout modern business and finance – the divorce of ownership and control – was identified by Adolf Berle and Gardiner Means eighty years ago.42 The attempt to tackle this issue by designing complex incentive schemes did not, in fact, align managerial interests with those of shareholders, still less align them with the long-term success of the company: today it has become the principal source of friction between companies and their shareholders.

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Venture capital had been devised for start-up and early-stage businesses, such as the Apple of the 1970s: the focus of private equity was on buy-outs of existing businesses from large corporations, or the refinancing of established companies with additional leverage. The high fee levels appropriate for investments of small size which required careful monitoring were applied to the much larger sums of money deployed in financial engineering. The industry drifted from its initial purposes, in ways that generated more revenue for intermediaries but less economic value. Apple, along with many other transformational new companies, was founded in the small area of California now known as Silicon Valley. Some other companies – such as Facebook – moved there at an early stage in their life.

The Finance Curse: How Global Finance Is Making Us All Poorer by Nicholas Shaxson

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, activist fund / activist shareholder / activist investor, Airbnb, airline deregulation, Alan Greenspan, anti-communist, bank run, banking crisis, Basel III, Bear Stearns, benefit corporation, Bernie Madoff, Big bang: deregulation of the City of London, Blythe Masters, Boris Johnson, Bretton Woods, British Empire, business climate, business cycle, capital controls, carried interest, Cass Sunstein, Celtic Tiger, central bank independence, centre right, Clayton Christensen, cloud computing, corporate governance, corporate raider, creative destruction, Credit Default Swap, cross-subsidies, David Ricardo: comparative advantage, demographic dividend, Deng Xiaoping, desegregation, Donald Trump, Etonian, export processing zone, failed state, fake news, falling living standards, family office, financial deregulation, financial engineering, financial innovation, forensic accounting, Francis Fukuyama: the end of history, full employment, gig economy, Gini coefficient, Glass-Steagall Act, global supply chain, Global Witness, high net worth, Ida Tarbell, income inequality, index fund, invisible hand, Jeff Bezos, junk bonds, Kickstarter, land value tax, late capitalism, light touch regulation, London Whale, Long Term Capital Management, low skilled workers, manufacturing employment, Mark Zuckerberg, Martin Wolf, megaproject, Michael Milken, Money creation, Mont Pelerin Society, moral hazard, neoliberal agenda, Network effects, new economy, Northern Rock, offshore financial centre, old-boy network, out of africa, Paul Samuelson, plutocrats, Ponzi scheme, price mechanism, proprietary trading, purchasing power parity, pushing on a string, race to the bottom, regulatory arbitrage, rent-seeking, road to serfdom, Robert Bork, Ronald Coase, Ronald Reagan, Savings and loan crisis, seminal paper, shareholder value, sharing economy, Silicon Valley, Skype, smart grid, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, sovereign wealth fund, special economic zone, Steve Ballmer, Steve Jobs, stock buybacks, Suez crisis 1956, The Chicago School, Thorstein Veblen, too big to fail, Tragedy of the Commons, transfer pricing, two and twenty, vertical integration, Wayback Machine, wealth creators, white picket fence, women in the workforce, zero-sum game

Trainline’s corporate structure is an example of this second aspect of financialisation, where the bosses of companies that create real wealth in the economy – by making widgets and sprockets, finding cures for malaria, selling toys or package holidays, or creating efficient platforms for selling rail tickets – are increasingly encouraged to turn their attentions away from the hard slog of trying to boost productivity and genuine entrepreneurship, and towards the more profitable sugar rush of financial engineering to tease out more profits for the owners. Half a century ago it was widely accepted that the purpose of corporations was not just to make profits, but also to serve employees, communities and wider society. In the era of financialisation of the last few decades, our businesses have undergone a massive transformation.

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In all countries this game isn’t just about the big players taking a bigger share of the pie; the pie has actually shrunk as workers have lost purchasing power and thus found themselves less able to buy goods, sapping demand for corporate output. This in turn has refocused the attention of corporate managers – away from investment and towards more financial engineering (and even more monopolisation) to improve profits. In the process we’ve traded balanced economies with plentiful, stable well-paying jobs and thriving communities for unbalanced economies, zero-hour contracts, atomised communities and cheap televisions – and they probably aren’t much cheaper, either.

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There’s certainly nothing wrong in principle with private-sector firms running care homes; a husband-and-wife team, for example, may be able to provide a better and more personalised service for forty patients than employees working directly for the council. The problem isn’t the private sector; it’s private equity, whose underlying business model is aggressive, financially engineered wealth extraction from as many stakeholders in a business as it can get its hands on. To borrow from the old Heineken commercials, private equity extracts from the parts that other companies can’t reach. It represents perhaps the clearest example of financialisation at work in our economies.

13 Bankers: The Wall Street Takeover and the Next Financial Meltdown by Simon Johnson, James Kwak

Alan Greenspan, American ideology, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, banking crisis, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, Bonfire of the Vanities, bonus culture, book value, break the buck, business cycle, business logic, buy and hold, capital controls, Carmen Reinhart, central bank independence, Charles Lindbergh, collapse of Lehman Brothers, collateralized debt obligation, commoditize, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency risk, Edward Glaeser, Eugene Fama: efficient market hypothesis, financial deregulation, financial engineering, financial innovation, financial intermediation, financial repression, fixed income, George Akerlof, Glass-Steagall Act, Gordon Gekko, greed is good, Greenspan put, Home mortgage interest deduction, Hyman Minsky, income per capita, information asymmetry, interest rate derivative, interest rate swap, junk bonds, Kenneth Rogoff, laissez-faire capitalism, late fees, light touch regulation, Long Term Capital Management, low interest rates, market bubble, market fundamentalism, Martin Wolf, Michael Milken, money market fund, moral hazard, mortgage tax deduction, Myron Scholes, Paul Samuelson, Ponzi scheme, price stability, profit maximization, proprietary trading, race to the bottom, regulatory arbitrage, rent-seeking, Robert Bork, Robert Shiller, Ronald Reagan, Saturday Night Live, Satyajit Das, Savings and loan crisis, sovereign wealth fund, Tax Reform Act of 1986, The Myth of the Rational Market, too big to fail, transaction costs, Tyler Cowen, value at risk, yield curve

“It is the prototype of the thoroughly modern investment bank—the not-so-benevolent King of the Street.”2 Salomon was the epitome of the new breed of Wall Street investment bank, built around a swashbuckling, risk-taking bond trading operation powered by “quants” recruited from academic research institutions and filled with “financial engineers” designing new products. Its strategy was to take large risks on its own account rather than simply taking fees for providing advice or executing trades. As Bianco put it, “What sets Salomon apart is the sheer scale on which it oper-ates in the markets, reflecting an appetite for risk unrivaled among financial middlemen.”

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Claudia Goldin and Lawrence Katz have examined data on Harvard undergraduates and found that while only 5 percent of men in classes around 1970 were in finance fifteen years after graduation, that figure tripled to 15 percent for classes around 1990.79 The share of each class entering banking and finance careers grew from under 4 percent in the 1960s to 23 percent in recent years.80 At Princeton’s School of Engineering and Applied Science, “Operations Research and Financial Engineering” became the most popular undergraduate major.81 The banks thus became major beneficiaries of the American educational system. Whether society benefited is another question. Kevin Murphy, Andrei Shleifer, and Robert Vishny have argued that society benefits more when talented people become entrepreneurs who start companies and create real innovations than when they go into rent-seeking activities that redistribute rather than increase wealth.82 If this is true, then this diversion of talent to Wall Street constituted a real tax on economic growth over the last two decades.

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It was possible to combine low-rated MBS tranches, mix them together, and create a new CDO, 60 percent or even 80 percent of which was rated AAA; even though the MBS (the inputs) had low ratings, it was unlikely that many of them would default at the same time—at least according to the models. Financial engineers even created CDO-squareds—CDOs whose raw material was other CDOs—and higher-order variants, in order to squeeze out higher yield at lower supposed risk.5 In the late 1990s, Wall Street became addicted to mortgage-backed securities and CDOs. As housing prices took off, it became easy to build models showing that MBS and CDOs had virtually no risk, because borrowers could always refinance their mortgages as long as prices were rising; even if they defaulted, rising prices meant that the investors would own valuable collateral.

In FED We Trust: Ben Bernanke's War on the Great Panic by David Wessel

Alan Greenspan, Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Bear Stearns, Berlin Wall, Black Swan, break the buck, business cycle, central bank independence, credit crunch, Credit Default Swap, crony capitalism, debt deflation, Fall of the Berlin Wall, financial engineering, financial innovation, financial intermediation, fixed income, full employment, George Akerlof, Glass-Steagall Act, Greenspan put, housing crisis, inflation targeting, information asymmetry, junk bonds, London Interbank Offered Rate, Long Term Capital Management, low interest rates, market bubble, Michael Milken, money market fund, moral hazard, mortgage debt, new economy, Northern Rock, price stability, quantitative easing, Robert Shiller, Ronald Reagan, Saturday Night Live, Savings and loan crisis, savings glut, Socratic dialogue, too big to fail

During the reign of Alan Greenspan — which wasn’t much of a republic — the smart people of the Federal Reserve allowed the housing bubble to inflate. They stood by as banks and investors made ever bigger bets on the flawed assumption that housing prices would never fall across the country. They encouraged financial engineering that created securities so complex that neither inventor nor seller nor buyer could fully understand them, instruments that proved toxic to those who bought them and to everyone around them. They shielded financial engineers from attempts at government regulation and restraint. With huge sums at stake, they trusted investors and traders to protect themselves — and the rest of us — better than even the smartest government regulator could hope to.

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But with no textbook or contingency plan beyond Ben Bernanke’s lifelong obsession with the Great Depression, he and those closest to him responded aggressively and creatively enough to reduce the chances of the Great Panic becoming another Great Depression. Using tools invented by discredited financial engineers, the Fed devised ways to lend money and buy assets that Bernanke’s predecessors hadn’t dared to contemplate. Despite resistance from inside the Fed — and a sluggish start — Bernanke ultimately took to heart his own critique of the Japanese central bank, which over a decade earlier had proved unwilling to experiment or try any policy that wasn’t absolutely guaranteed to work.

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Instead, Bush appointed Kohn to be Bernanke’s vice chairman in the spring of 2006, passing over Mishkin, who was named a plain old governor. Kohn was the institutional memory in the Bernanke brain trust, the one man in the room who could plausibly say: “This is what Greenspan would have done in this situation.” He was often the one to find the flaws in Bernanke’s latest bit of creative financial engineering. Kohn had been among Bernanke’s intellectual adversaries when both were mere governors. Bernanke thought Greenspan’s approach to monetary policy relied too much on the chairman’s discretion and not nearly enough on well-explained rules. Along with Geithner, Kohn long had been on the other side, defending Greenspan’s approach.

Money for Nothing by Thomas Levenson

Albert Einstein, asset-backed security, bank run, British Empire, carried interest, clockwork universe, credit crunch, do well by doing good, Edmond Halley, Edward Lloyd's coffeehouse, experimental subject, failed state, fake news, Fellow of the Royal Society, fiat currency, financial engineering, financial innovation, Fractional reserve banking, income inequality, Isaac Newton, joint-stock company, land bank, market bubble, Money creation, open economy, price mechanism, quantitative easing, Republic of Letters, risk/return, side project, South Sea Bubble, The Wealth of Nations by Adam Smith, tontine

For several years, the South Sea Company itself had nibbled around the edges of this market, completing a handful of minor deals, but its directors now aimed at a vastly more ambitious project—one that would, if it worked, solve Britain’s borrowing problem once and for all. They proposed a heroic attempt at what we would now call financial engineering—taking the whole of the national debt, accumulated over a seemingly endless series of wars, and turning it into shares of a private company—theirs—which could be traded back and forth at will in the nascent stock exchange. In its partisans’ view, that would be the saving of the nation. Alternatively, as the skeptical Defoe warned, the clever men of Exchange Alley had figured out a way to get rich off of the public interest: they were “ready, as Occasion offers, and Profit presents, to Stock-jobb [buy and sell] the Nation, couzen [trick] the Parliament, ruffle the Bank, run up and run down Stocks, and put the Dice upon the whole Town.”

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The proposition to lottery holders—exchange your assets for something that paid a bit less but offered more flexibility—was wholly dependent on Exchange Alley. That was where loathed jobbers and brokers would turn this new asset, shares in a joint-stock company, into cash. The market’s reaction, then, was a measure of how well this early example of financial engineering actually worked in real life. So how did it go? Just fine! Throughout the summer of 1719, none of Defoe’s dire warnings about Exchange Alley came true. Quite the reverse, in fact, as the progress of the Company stock for lottery bonds demonstrated, revealing a basic flaw in Defoe’s grasp of the new markets in money.

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There had been no change in the numbers for the deal, no land bought or projects launched…nothing. This was the triumph of hope, or perhaps a demonstration of just how easy it was to push the unwary along Exchange Alley—with more to come. In late April the Company’s shareholders voted to allow the directors to lend money with South Sea stock as the collateral—creating a kind of circular financial engine, pumping more cash into a rising market, where each step up inflated the nominal value of the pledged shares, which could then be used to justify more lending, more cash, and, when brought to Jonathan’s or Garraway’s, more demand and hence higher prices on the Exchange. As financial chronicler P.

Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

Alan Greenspan, Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Bear Stearns, behavioural economics, Berlin Wall, Bernie Madoff, bitcoin, Bob Litterman, Bonfire of the Vanities, bonus culture, break the buck, Brexit referendum, Brownian motion, business cycle, business process, butterfly effect, buy and hold, capital asset pricing model, Captain Sullenberger Hudson, carbon tax, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, confounding variable, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, democratizing finance, Diane Coyle, diversification, diversified portfolio, do well by doing good, double helix, easy for humans, difficult for computers, equity risk premium, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial engineering, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Glass-Steagall Act, global macro, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, information security, interest rate derivative, invention of the telegraph, Isaac Newton, it's over 9,000, James Watt: steam engine, Jeff Hawkins, Jim Simons, job satisfaction, John Bogle, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, language acquisition, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, megaproject, merger arbitrage, meta-analysis, Milgram experiment, mirror neurons, money market fund, moral hazard, Myron Scholes, Neil Armstrong, Nick Leeson, old-boy network, One Laptop per Child (OLPC), out of africa, p-value, PalmPilot, paper trading, passive investing, Paul Lévy, Paul Samuelson, Paul Volcker talking about ATMs, Phillips curve, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, proprietary trading, public intellectual, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Solow, Sam Peltzman, Savings and loan crisis, seminal paper, Shai Danziger, short selling, sovereign wealth fund, Stanford marshmallow experiment, Stanford prison experiment, statistical arbitrage, Steven Pinker, stochastic process, stocks for the long run, subprime mortgage crisis, survivorship bias, systematic bias, Thales and the olive presses, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, uptick rule, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

By recruiting a young engineer with a master’s degree in applied mathematics from Caltech in 1967 to MIT’s Ph.D. program in economics, Samuelson passed his baton to the next generation of financial scholarship. His Nobel Prize–winning protégé, Robert C. Merton, went on to create much of what is now known as financial engineering, as well as the analytical foundations of at least three multi-trillion-dollar industries: exchange-traded options markets; over-the-counter derivatives and structured products; and credit derivatives. But the exalted role of theory in economics isn’t due to Samuelson alone. It was created by the cumulative efforts of a number of intellectual giants during the half-century following the Second World War.

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When you’re swinging for the fences and going for home runs, you’re going to strike out a lot more than if you’re trying for singles or doubles. So that’s where things stand: drug development is getting harder; the financial risks are getting bigger; and early-stage funding is getting scarcer. What can we do about it? Well, what if we could change the risk/reward profile of the drug development process through financial engineering? We do it all the time for other investments. Here’s how. Instead of investing in one project at a time, suppose we invest in 150 of them, all at the same time. I know that sounds crazy. First, you’d need 150 × $200 million, or $30 billion; where are you going to get that kind of money? As an economist, my answer is simple: Assume we have $30 billion.

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(This isn’t a total loss for the bondholders. The intellectual property of 150 biopharma projects, even if unsuccessful, is still likely to be valuable.) At current interest rates, more than $27 billion can be financed by issuing long-term A-rated bonds.14 And if we use all the other tools of financial engineering—securitization, collateralized debt obligations, credit default swaps, and other types of derivative securities—we can do even better. At this point, you’re probably wondering whether this is really a good idea. After all, didn’t we encounter these very same financial innovations in chapter 10, when we were reviewing the recent financial crisis?

Palace Coup: The Billionaire Brawl Over the Bankrupt Caesars Gaming Empire by Sujeet Indap, Max Frumes

Airbnb, Bear Stearns, Blythe Masters, book value, business cycle, Carl Icahn, coronavirus, corporate governance, corporate raider, Credit Default Swap, data science, deal flow, Donald Trump, family office, fear of failure, financial engineering, fixed income, Jeffrey Epstein, junk bonds, lockdown, low interest rates, Michael Milken, mortgage debt, NetJets, power law, ride hailing / ride sharing, Right to Buy, Robert Solow, Savings and loan crisis, shareholder value, super pumped, Travis Kalanick

Caesars filed for bankruptcy in early 2015 under Chapter 11 of the Bankruptcy Code, leading to a court-supervised free-for-all to determine who would have the right to take control of the revitalized company: Apollo and its partner TPG Capital, or the vulture distressed-debt investors, who happened to be the world’s biggest, baddest hedge funds. The bankruptcy would eventually shine a harsh light on Rowan and Sambur’s relentless financial engineering that had sustained Apollo’s investment in Caesars. Their machinations had led to credible accusations of a modern day casino heist; fraudulent transfers and boardroom impropriety to the tune of $5 billion in liability. All the while, a complicated game of three-dimensional chess had broken out between multiple creditor groups and the private equity owners.

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Distressed investing was a natural extension of the junk bond explosion of the 1980s and its subsequent collapse. Loans and bonds were no longer just a passive financing tool that earned steady interest payments; rather they could be opportunistically bought up and weaponized to take over troubled companies. Financial engineers like Black and Rowan who were experts in valuation, deal structuring, and complex negotiations, were the ideal distressed investors. Years later, Rowan recalled that when he had joined Drexel, he believed that he was five years too late—all the money had been made and all the fun had. What he said he had learned from the Drexel blow-up and the subsequent birth of Apollo was that, “you want chaos, you want things to be shaken up, you want the system to be brought down and built up again.

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In its early years, Texas Pacific Group bought such household names as America West Airlines, J.Crew, Ducati, and Burger King. Bonderman also took a personal stake in Ryanair in 1996, where he remained on the board until 2020. On the strength of the Continental investment, TPG developed a reputation less as a slash-and-burn financial engineer and more as an operations expert that could fix and grow underperforming assets. Its 1993 inaugural fund returned an annual rate of 36 percent to investors. Meanwhile, Apollo’s initial 1990 and 1993 funds returned roughly 50 percent. Rowan would boast that Apollo became the largest profit center of Credit Lyonnais in those years, earning the French institution billions of dollars.

Finance and the Good Society by Robert J. Shiller

Alan Greenspan, Alvin Roth, bank run, banking crisis, barriers to entry, Bear Stearns, behavioural economics, benefit corporation, Bernie Madoff, buy and hold, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, cognitive dissonance, collateralized debt obligation, collective bargaining, computer age, corporate governance, Daniel Kahneman / Amos Tversky, democratizing finance, Deng Xiaoping, diversification, diversified portfolio, Donald Trump, Edward Glaeser, eurozone crisis, experimental economics, financial engineering, financial innovation, financial thriller, fixed income, full employment, fundamental attribution error, George Akerlof, Great Leap Forward, Ida Tarbell, income inequality, information asymmetry, invisible hand, John Bogle, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, land reform, loss aversion, Louis Bachelier, Mahatma Gandhi, Mark Zuckerberg, market bubble, market design, means of production, microcredit, moral hazard, mortgage debt, Myron Scholes, Nelson Mandela, Occupy movement, passive investing, Ponzi scheme, prediction markets, profit maximization, quantitative easing, random walk, regulatory arbitrage, Richard Thaler, Right to Buy, road to serfdom, Robert Shiller, Ronald Reagan, selection bias, self-driving car, shareholder value, Sharpe ratio, short selling, Simon Kuznets, Skype, social contagion, Steven Pinker, tail risk, telemarketer, Thales and the olive presses, Thales of Miletus, The Market for Lemons, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, Vanguard fund, young professional, zero-sum game, Zipcar

Printed in the United States of America 10 9 8 7 6 5 4 3 Contents Preface to the Paperback Edition Preface vii xiii Introduction: Finance, Stewardship, and Our Goals Part One Roles and Responsibilities 1 1. Chief Executive Officers 2. Investment Managers 3. Bankers 4. Investment Bankers 5. Mortgage Lenders and Securitizers 6. Traders and Market Makers 7. Insurers 8. Market Designers and Financial Engineers 9. Derivatives Providers 10. Lawyers and Financial Advisers 11. Lobbyists 12. Regulators 13. Accountants and Auditors 14. Educators 15. Public Goods Financiers 16. Policy Makers in Charge of Stabilizing the Economy 17. Trustees and Nonprofit Managers 18. Philanthropists 19 27 37 45 50 57 64 69 75 81 87 94 100 103 107 119 124 Part Two Finance and Its Discontents 19.

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The intelligent response to stories of human su ering in the BP oil spill or the Haitian earthquake or agricultural famines around the world is to recognize that the real costs of these disasters could be met by better risk management—by better insurance. There is certainly a role for those who wish to enter the field of insurance to make this happen. Chapter 8 Market Designers and Financial Engineers Market designers, sometimes called mechanism designers, start with a problem—the need for a market solution to some real human quandary—and then design a market and associated contracts to solve the problem. They are using nancial and economic theory to create “trades” that leave people better o .

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The point of the dating service example is to provide a real sense of the mathematical and theoretical complexity of even our most intimate problems, and to help us appreciate that nancial theory ought to be involved in the future solution of these problems. In the future—thanks to improvements in information technology as well as economic science—we can expect to see more and better mechanisms to help us make all manner of economic decisions. Financial engineers can help us solve such problems in the future just as mechanical engineers have designed the arti cial heart or electrical engineers have designed the mobile phone. Chapter 9 Derivatives Providers In recent years, the term derivatives has become a dirty word, blamed by many for real evils, including the severe nancial crisis that began in 2007.

The Cost of Inequality: Why Economic Equality Is Essential for Recovery by Stewart Lansley

"World Economic Forum" Davos, Adam Curtis, air traffic controllers' union, Alan Greenspan, AOL-Time Warner, banking crisis, Basel III, Big bang: deregulation of the City of London, Bonfire of the Vanities, borderless world, Branko Milanovic, Bretton Woods, British Empire, business cycle, business process, call centre, capital controls, collective bargaining, corporate governance, corporate raider, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, crony capitalism, David Ricardo: comparative advantage, deindustrialization, Edward Glaeser, Everybody Ought to Be Rich, falling living standards, financial deregulation, financial engineering, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, Goldman Sachs: Vampire Squid, high net worth, hiring and firing, Hyman Minsky, income inequality, James Dyson, Jeff Bezos, job automation, job polarisation, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, laissez-faire capitalism, Larry Ellison, light touch regulation, Londongrad, Long Term Capital Management, low interest rates, low skilled workers, manufacturing employment, market bubble, Martin Wolf, Mary Meeker, mittelstand, mobile money, Mont Pelerin Society, Myron Scholes, new economy, Nick Leeson, North Sea oil, Northern Rock, offshore financial centre, oil shock, plutocrats, Plutonomy: Buying Luxury, Explaining Global Imbalances, proprietary trading, Right to Buy, rising living standards, Robert Shiller, Robert Solow, Ronald Reagan, savings glut, shareholder value, The Great Moderation, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, Tyler Cowen, Tyler Cowen: Great Stagnation, Washington Consensus, Winter of Discontent, working-age population

In the case of the fourteen most successful deals between 2005 and 2007, ones which yielded exceptionally high returns, as much as a half of these yields came from financial engineering, almost a third from the stock market boom, and less than a fifth from improved management.349 Once debt leveraging is stripped out, the returns achieved suggest ‘mixed and in some cases, even mediocre results’. According to a study by Manchester Business School, the main impact of private equity has been the use of financial engineering to ‘rearrange claims for the benefit of those who own equity, and ensure value capture by a managerial elite of general partners who run funds and senior managers who run the operating businesses invested in.’350 While the architects of public-to-private deals have walked away with giant jackpots, companies have mostly been stripped of their key assets, especially property portfolios, and landed with heavy debt burdens.

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Boardrooms, led by the hand of a newly rejuvenated finance sector, one awash with access to great pools of global cash, have turned to buying, merging, breaking up, repackaging and selling on existing companies. Scores of high-street names—from the AA to Debenhams—have been bought up by consortiums of corporate financiers. Far from bringing a more productive economy, healthier companies and more jobs, the financial engineering of these companies in a diversity of ways has often been detrimental to the firms, while fuelling the construction of a separate economy of the super rich. The categorical division between the money and the productive economy is well illustrated by the 2007 crisis and its aftermath. After hopeful signs of recovery in 2010, productive activity in the world’s richest economies has stalled and growth forecasts are being adjusted sharply downward.

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They calculate the possible synergies of a merger and entice companies with the prospect of a soaring share price.’191 This ‘incessant pressure to transact’ as former senior investment banker Philip Augar has described it, explains the increasing emphasis on merger and acquisition activity, financial engineering and the big top-down cost reduction strategies which have brought big short-term rewards but mostly limited, if any, benefit for long-term performance.192 All this was made possible by the huge cash surpluses being generated across the world. Once cautious pension-funds and endowment trusts deposited, along with oligarchs and monopolists, an increasing proportion of their funds into the highly risky investments being made by the racier end of the City.

Crisis Economics: A Crash Course in the Future of Finance by Nouriel Roubini, Stephen Mihm

Alan Greenspan, Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, barriers to entry, Bear Stearns, behavioural economics, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, bond market vigilante , bonus culture, Bretton Woods, BRICs, British Empire, business cycle, call centre, capital controls, Carmen Reinhart, central bank independence, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, dark matter, David Ricardo: comparative advantage, debt deflation, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial engineering, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, Glass-Steagall Act, global pandemic, global reserve currency, Gordon Gekko, Greenspan put, Growth in a Time of Debt, housing crisis, Hyman Minsky, information asymmetry, interest rate swap, invisible hand, Joseph Schumpeter, junk bonds, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, low interest rates, margin call, market bubble, market fundamentalism, Martin Wolf, means of production, Minsky moment, money market fund, moral hazard, mortgage debt, mortgage tax deduction, new economy, Northern Rock, offshore financial centre, oil shock, Paradox of Choice, paradox of thrift, Paul Samuelson, Ponzi scheme, price stability, principal–agent problem, private sector deleveraging, proprietary trading, pushing on a string, quantitative easing, quantitative trading / quantitative finance, race to the bottom, random walk, regulatory arbitrage, reserve currency, risk tolerance, Robert Shiller, Satyajit Das, Savings and loan crisis, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, subprime mortgage crisis, Suez crisis 1956, The Great Moderation, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, too big to fail, tulip mania, Tyler Cowen, unorthodox policies, value at risk, We are all Keynesians now, Works Progress Administration, yield curve, Yom Kippur War

All of them worked according to the same principle. Anyone holding a plain-vanilla mortgage-backed security necessarily took on a certain amount of risk: the homeowner might default, for example, or simply prepay the loan, thereby depriving the lender of the additional interest payments it would earn if the loan was paid off on schedule. Financial “engineers” on Wall Street came up with an elegant solution: the CDO. The CDO would be divided into slices, or tranches. The simplest CDOs had only three tranches: equity, mezzanine, and senior. The purchasers of an equity tranche got the highest return but took on the greatest risk: if any homeowners in the underlying pool defaulted, the holders of the equity tranche would see losses before anyone else.

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This state of affairs may seem unique and unprecedented, and it was, but only in the particulars. Lack of transparency, underestimation of risk, and cluelessness about how new financial products might behave when subjected to significant stress are recurrent problems in many crises, past and present. Moral Hazard While the financial engineers who gave us monstrosities like the CDO3 deserve plenty of blame, many other problems were accumulating that went far beyond the obvious flaws in the securitization food chain. The faulty ways in which financial firms governed themselves helped lay the groundwork for the recent crisis as well.

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As compensation soared, graduates of elite schools increasingly went to Wall Street. In fact, among Harvard seniors surveyed in 2007, a whopping 58 percent of the men joining the workforce were bound for jobs in finance or consulting. In a curious paradox, the United States now has too many financial engineers and not enough mechanical or computer engineers. Not coincidentally, the last time the United States saw comparable growth in the financial sector was in the years leading up to . . . 1929. In the 1930s, compensation in the financial sector plummeted, a victim of regulatory crackdowns that made banking a boring, if more respectable, profession.

Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown by Philip Mirowski

"there is no alternative" (TINA), Adam Curtis, Alan Greenspan, Alvin Roth, An Inconvenient Truth, Andrei Shleifer, asset-backed security, bank run, barriers to entry, Basel III, Bear Stearns, behavioural economics, Berlin Wall, Bernie Madoff, Bernie Sanders, Black Swan, blue-collar work, bond market vigilante , bread and circuses, Bretton Woods, Brownian motion, business cycle, capital controls, carbon credits, Carmen Reinhart, Cass Sunstein, central bank independence, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, constrained optimization, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, dark matter, David Brooks, David Graeber, debt deflation, deindustrialization, democratizing finance, disinformation, do-ocracy, Edward Glaeser, Eugene Fama: efficient market hypothesis, experimental economics, facts on the ground, Fall of the Berlin Wall, financial deregulation, financial engineering, financial innovation, Flash crash, full employment, George Akerlof, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Greenspan put, Hernando de Soto, housing crisis, Hyman Minsky, illegal immigration, income inequality, incomplete markets, information asymmetry, invisible hand, Jean Tirole, joint-stock company, junk bonds, Kenneth Arrow, Kenneth Rogoff, Kickstarter, knowledge economy, l'esprit de l'escalier, labor-force participation, liberal capitalism, liquidity trap, loose coupling, manufacturing employment, market clearing, market design, market fundamentalism, Martin Wolf, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Naomi Klein, Nash equilibrium, night-watchman state, Northern Rock, Occupy movement, offshore financial centre, oil shock, Pareto efficiency, Paul Samuelson, payday loans, Philip Mirowski, Phillips curve, Ponzi scheme, Post-Keynesian economics, precariat, prediction markets, price mechanism, profit motive, public intellectual, quantitative easing, race to the bottom, random walk, rent-seeking, Richard Thaler, road to serfdom, Robert Shiller, Robert Solow, Ronald Coase, Ronald Reagan, Savings and loan crisis, savings glut, school choice, sealed-bid auction, search costs, Silicon Valley, South Sea Bubble, Steven Levy, subprime mortgage crisis, tail risk, technoutopianism, The Chicago School, The Great Moderation, the map is not the territory, The Myth of the Rational Market, the scientific method, The Theory of the Leisure Class by Thorstein Veblen, The Wisdom of Crowds, theory of mind, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, Tobin tax, tontine, too big to fail, transaction costs, Tyler Cowen, vertical integration, Vilfredo Pareto, War on Poverty, Washington Consensus, We are the 99%, working poor

So I think that people who are in finance today have a moral obligation to help advance the trend toward democratisation of finance.48 So how will more financial engineering help us out of the hole left by the global crisis? Some say the working-class “democratization” was just feedstock so that Wall Street and the City could securitize ever-expanding volumes of debt (while getting it graded AAA and foisting it off onto gullible money-market funds) as inadequate compensation for the dismantling of the welfare state; but people like Shiller say that the poverty and inequality could actually be mitigated by further financial engineering. The detailed examples provided in above turn out to be a little underwhelming, such as a “social impact bond” that pays a return if a particular social goal is met, or crowdfunding of public investment projects.

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There is a fourth case, highlighted here not so much because of this figure’s intimate direct involvement in the crisis (unlike Summers, Feldstein, and Gorton), but rather because he was the other designated reviewer of a marathon evaluation of twenty-one books devoted to the crisis in the JEL.112 Andrew Lo is the Harris & Harris Group Professor of Finance at the MIT Sloan School of Management and the director of MIT’s Laboratory for Financial Engineering. In other words, in the rarefied world of the “quants” who built the models that underpinned most of the complexity in the run-up to the crisis, he was chief guru. The only private affiliation listed on his personal website is as founder and chief scientist at the hedge fund AlphaSimplex, but on its website we learn, “Andrew has 24 years of industry experience.

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(This was probably one of the reasons he was chosen to survey the crisis landscape by the JEL.) He opted for this position as early as October 2009, in a public lecture produced by the National Science Foundation (so much for the neutrality of the funders of the natural sciences), which argued that blaming financial engineering for the crisis was on a par with blaming accounting, or the system of natural numbers.113 There he also mooted a proposition he has returned to repeatedly in the interim, that the causes of the crisis should instead be rooted in individual psychology, such that any blame is diffuse, or “all of us participated to some extent in the crisis.”

What Went Wrong: How the 1% Hijacked the American Middle Class . . . And What Other Countries Got Right by George R. Tyler

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, 8-hour work day, active measures, activist fund / activist shareholder / activist investor, affirmative action, Affordable Care Act / Obamacare, Alan Greenspan, bank run, banking crisis, Basel III, Bear Stearns, behavioural economics, benefit corporation, Black Swan, blood diamond, blue-collar work, Bolshevik threat, bonus culture, British Empire, business cycle, business process, buy and hold, capital controls, Carmen Reinhart, carried interest, cognitive dissonance, collateralized debt obligation, collective bargaining, commoditize, company town, compensation consultant, corporate governance, corporate personhood, corporate raider, corporate social responsibility, creative destruction, credit crunch, crony capitalism, crowdsourcing, currency manipulation / currency intervention, David Brooks, David Graeber, David Ricardo: comparative advantage, declining real wages, deindustrialization, Diane Coyle, disruptive innovation, Double Irish / Dutch Sandwich, eurozone crisis, financial deregulation, financial engineering, financial innovation, fixed income, Ford Model T, Francis Fukuyama: the end of history, full employment, George Akerlof, George Gilder, Gini coefficient, Glass-Steagall Act, Gordon Gekko, Greenspan put, hiring and firing, Ida Tarbell, income inequality, independent contractor, invisible hand, job satisfaction, John Markoff, joint-stock company, Joseph Schumpeter, junk bonds, Kenneth Rogoff, labor-force participation, laissez-faire capitalism, lake wobegon effect, light touch regulation, Long Term Capital Management, low interest rates, manufacturing employment, market clearing, market fundamentalism, Martin Wolf, minimum wage unemployment, mittelstand, Money creation, moral hazard, Myron Scholes, Naomi Klein, Northern Rock, obamacare, offshore financial centre, Paul Samuelson, Paul Volcker talking about ATMs, pension reform, performance metric, Pershing Square Capital Management, pirate software, plutocrats, Ponzi scheme, precariat, price stability, profit maximization, profit motive, prosperity theology / prosperity gospel / gospel of success, purchasing power parity, race to the bottom, Ralph Nader, rent-seeking, reshoring, Richard Thaler, rising living standards, road to serfdom, Robert Gordon, Robert Shiller, rolling blackouts, Ronald Reagan, Sand Hill Road, Savings and loan crisis, shareholder value, Silicon Valley, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, sovereign wealth fund, Steve Ballmer, Steve Jobs, stock buybacks, subprime mortgage crisis, The Chicago School, The Spirit Level, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, transcontinental railway, transfer pricing, trickle-down economics, tulip mania, Tyler Cowen, Tyler Cowen: Great Stagnation, union organizing, Upton Sinclair, upwardly mobile, women in the workforce, working poor, zero-sum game

It has even featured extraction of a sort, with the deregulated banking industry mining customers, families, and even taxpayers, using the tools made available by credit creation and deregulation to conduct opaque financial engineering. Like Hapsburg Spain, record wealth has been redistributed during the Reagan decline to enrich relatively few, while weakening the American metropole, especially the high-value technical services sector and industrial foundation that made the twentieth century the American century. The Financialization of America That portion of the American economy composed of financial engineering by Alan Greenspan’s pollinators was 8.3 percent of GDP in 2011, surpassing health care to be the second largest sector.

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Wall Street and local bankers were forced to be cautious and methodical, careful with your money, not jittery financial entrepreneurs seeking windfalls, eager and able to gamble with your deposits. And they earned far less than executives at firms such as GM, which actually generated real wealth. Manufacturing careers were the ticket to a bright future back then, rather than the financial engineering jobs of today, conjuring opaque securities. That same prudent mentality carried over to the government, where federal budget deficits were tiny, with taxes and spending nearly in balance and the national debt from World War II shrinking steadily under both Democratic and Republican presidents.

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In reality, real wages for college graduates are lower today than a generation or more ago. Education and pluck are obviously not sufficient keys to riches; if they were, computer scientists and other engineers, mathematicians, and Harvard professors would be reaping millions of dollars a year rather than financial engineers and corporate executives. Another myth is that the economies of northern Europe are misfiring and sclerotic. Yet, these are economies where productivity has grown one-third faster than America’s for three decades. In fact, those in the best position to know—American corporations—are enthralled with rich old Europe, where they have created many thousands of jobs paying $10 an hour more than at home.

The Decline and Fall of IBM: End of an American Icon? by Robert X. Cringely

AltaVista, Bernie Madoff, business cycle, business process, Carl Icahn, cloud computing, commoditize, compound rate of return, corporate raider, financial engineering, full employment, Great Leap Forward, if you build it, they will come, immigration reform, interchangeable parts, invention of the telephone, Khan Academy, knowledge worker, low skilled workers, managed futures, Paul Graham, platform as a service, race to the bottom, remote working, Robert Metcalfe, Robert X Cringely, shareholder value, Silicon Valley, six sigma, software as a service, Steve Jobs, stock buybacks, tech worker, TED Talk, Toyota Production System, Watson beat the top human players on Jeopardy!, web application, work culture

The resource actions, LEAN, cost-cutting atmosphere, etc. are all symptoms of the bigger problem, in that IBM cannot maintain high value for the business. To put it bluntly, management has run the company into the ground. For their part, the top executives have focused on financial engineering — preserving stock value while they themselves cash out at opportune moments. IBM’s 2015 plan is just another example in a long line of financial tricks. The real “crime” in this whole scenario is that people are confused about what IBM actually is. At its heart, IBM has become a financial engineering operation masquerading as a technology firm. The corporate emphasis is not on product or services (“content” per Steve Jobs), but on EARNINGS PER SHARE.

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Chapter Six The 2015 Roadmap to $20 earnings per share: IBMers call it the “Death March 2015” Chapter Seven A Tale of Two Division Sales: IBM sells its PC division to Lenovo in 2004, and ten years later negotiates a deal to sell its server business to the same company. Big mistake? Chapter Eight Financial Engineering: How are all those share buybacks with borrowed money working out for ya, IBM? Chapter Nine An IT Labor Economics Lesson from Memphis for IBM: The company carelessly loses two big customers. Chapter Ten The Ginni Paradox or How to Fix IBM: CEO Ginni Rometty bets the farm that Palmisano was right to focus on shareholder earnings.

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IBM could become the leader of large arrays of inexpensive Power- and ARM-based servers. The market is moving to commodity processors. IBM needs to evolve too, and be part of that future. But as the Intel server sales show, they aren’t evolving and won’t evolve. And this is another reason I fear the company is doomed. CHAPTER EIGHT Financial Engineering If, as is the case at IBM, the primary corporate goal is to hit a certain earnings target set years before by a guy who no longer even works at the company, you’d better have some powerful financial tools to help the company get there. Growing earnings-per-share can be done by increasing profits, by decreasing the number of outstanding shares or by a combination of both techniques.

Optimization Methods in Finance by Gerard Cornuejols, Reha Tutuncu

asset allocation, call centre, constrained optimization, correlation coefficient, diversification, financial engineering, finite state, fixed income, frictionless, frictionless market, index fund, linear programming, Long Term Capital Management, passive investing, Sharpe ratio, transaction costs, value at risk

While individuals generally just have to live with such risks, financial and other institutions can and very often must manage risk using sophisticated mathematical techniques. Managing risk requires a good understanding of risk which comes from quantitative risk measures that adequately reflect the vulnerabilities of a company. Perhaps the best-known risk measure is Value-at-Risk (VaR) developed by financial engineers at J.P. Morgan. VaR is a measure related to percentiles of loss distributions and represents the predicted maximum loss with a specified probability level (e.g., 95%) over a certain period of time (e.g., one day). Consider, for example, a random variable 3.3. RISK MEASURES: CONDITIONAL VALUE-AT-RISK 37 X that represents loss from an investment portfolio over a fixed period of time.

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While stochastic programming models have existed for several decades, computational technology has only recently allowed the solution of realistic size problems. The field continues to develop with the advancement of available algorithms and computational power. It is a popular modeling tool for problems in a variety of disciplines including financial engineering. In analogy to the generic optimization problem (OP) we considered in the Introduction, a generic stochastic programming problem can be formulated as follows: (SP) minx E[f (x, p)] E[gi (x, p)] = 0, i ∈ E E[gi (x, p)] ≥ 0, i ∈ I, x ∈ S. (6.1) In this formulation, x represents our n-dimensional decision variable vector and p represents the uncertain parameters of the optimization problem.

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Journal of Portfolio Management, Fall:49–58, 1994. [16] R. H. Tütüncü and M. Koenig. Robust asset allocation. Technical report, Department of Mathematical Sciences, Carnegie Mellon University, August 2002. To appear in Annals of Operations Research. [17] S. Uryasev. Conditional value-at-risk: Optimization algorithms and applications. Financial Engineering News, 14:1–6, 2000.

The Lords of Easy Money: How the Federal Reserve Broke the American Economy by Christopher Leonard

2021 United States Capitol attack, Affordable Care Act / Obamacare, Airbnb, Alan Greenspan, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, collateralized debt obligation, coronavirus, corporate governance, COVID-19, Donald Trump, Dutch auction, financial engineering, financial innovation, fixed income, Ford Model T, forensic accounting, forward guidance, full employment, glass ceiling, Glass-Steagall Act, global reserve currency, Greenspan put, hydraulic fracturing, income inequality, inflation targeting, Internet Archive, inverted yield curve, junk bonds, lockdown, long and variable lags, Long Term Capital Management, low interest rates, manufacturing employment, market bubble, Money creation, mortgage debt, new economy, obamacare, pets.com, power law, proprietary trading, quantitative easing, reserve currency, risk tolerance, Robinhood: mobile stock trading app, Ronald Reagan, Silicon Valley, stock buybacks, too big to fail, yield curve

It showed that the decision to fight price inflation rather than asset inflation happened gradually, but was unmistakable by the 1990s. This wasn’t just a quirk of the Greenspan era. It set a permanent pattern. Greenspan was rewarded for the decision. It helped explain why lawmakers in both parties praised him at the public hearings. Greenspan appeared to be the most talented financial engineer of his generation, and the key to this success, along with the mystery of it, was that he managed to stimulate the economy without stoking price inflation. Asset inflation, however, was out of control by 1998. But this didn’t raise much public concern. When asset inflation gets out of hand, people don’t call it inflation.

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The company had just borrowed $1.5 billion in cheap debt, but it didn’t plan to use the cash to build a factory, invest in research, or hire workers. Instead, the company used the money to buy back shares of its own stock. This made sense because the stocks paid a dividend of 2.5 percent, while the debt only cost between 0.45 percent and 1.6 percent to borrow. It was a finely played maneuver of financial engineering that increased the company’s debt, drove up its stock price, and gave a handsome reward to shareholders. Fisher drove home the point by relating his conversation with the CFO. “He said—and I have his permission to quote—‘I’m not going to use it to create a single job,’ ” Fisher reported. “And I think this is the issue.

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Rexnord wouldn’t turn a profit until 2012, and it paid millions of dollars in interest costs each year. But Adams wasn’t deterred. Apollo still owned Rexnord, and in the world of private equity, there was more to running a business than turning a profit or being debt-free. Rexnord had become Apollo’s strategic vehicle to generate periodic windfalls through financial engineering. Right after Apollo bought the company, for example, it loaded Rexnord down with $660 million in new debt, which was used to buy an industrial plumbing firm called Zurn Industries. This expanded Rexnord’s reach into new markets, and created a new pathway for even more debt-fueled acquisitions.

Tools for Computational Finance by Rüdiger Seydel

bioinformatics, Black-Scholes formula, Brownian motion, commoditize, continuous integration, discrete time, financial engineering, implied volatility, incomplete markets, interest rate swap, linear programming, London Interbank Offered Rate, mandelbrot fractal, martingale, random walk, risk free rate, stochastic process, stochastic volatility, transaction costs, value at risk, volatility smile, Wiener process, zero-coupon bond

Algorithms 18 (1998) 209-232. [GeG03] T. Gerstner, M. Griebel: Dimension-adaptive tensor-product quadrature. Computing 70,4 (2003). [GiRS96] W.R. Gilks, S. Richardson, D.J. Spiegelhalter (Eds.): Markov Chain Monte Carlo in Practice. Chapman & Hall, Boca Raton (1996). [Gla04] P. Glasserman: Monte Carlo Methods in Financial Engineering. Springer, New York (2004). [GV96] G. H. Golub, C. F. Van Loan: Matrix Computations. Third Edition. The John Hopkins University Press, Baltimore (1996). [GK01] L. Grüne, P.E. Kloeden: Pathwise approximation of random ODEs. BIT 41 (2001) 710-721. [Ha85] W. Hackbusch: Multi-Grid Methods and Applications.

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Pergamon Press, Elmsford (1964). I. Karatzas, S.E. Shreve: Brownian Motion and Stochastic Calculus. Second Edition. Springer Graduate Texts, New York (1991). I. Karatzas, S.E. Shreve: Methods of Mathematical Finance. Springer, New York (1998). H.M. Kat: Pricing Lookback options using binomial trees: An evaluation. J. Financial Engineering 4 (1995) 375–397. T.R. Klassen: Simple, fast and flexible pricing of Asian options. J. Computational Finance 4,3 (2001) 89-124. P.E. Kloeden, D. Platen: Numerical Solution of Stochastic Differential Equations. Springer, Berlin (1992). P.E. Kloeden, E. Platen, H. Schurz: Numerical Solution of SDE Through Computer Experiments.

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C.A. Los: Computational Finance: A Scientific Perspective. World Scientific, Singapore (2001). T. Lux: The socio-economic dynamics of speculative markets: interacting agents, chaos, and the fat tails of return distributions. J. Economic Behavior & Organization 33 (1998) 143-165. Y.-D. Lyuu: Financial Engineering and Computation. Principles, Mathematics, Algorithms. Cambridge University Press, Cambridge (2002). L.W. MacMillan: Analytic approximation for the American put option. Advances in Futures and Options Research 1 (1986) 119-139. R. Mainardi, M. Roberto, R. Gorenflo, E. Scalas: Fractional calculus and continuous-time finance II: the waiting-time distribution.

The Clash of the Cultures by John C. Bogle

Alan Greenspan, asset allocation, buy and hold, collateralized debt obligation, commoditize, compensation consultant, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, financial intermediation, fixed income, Flash crash, Glass-Steagall Act, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, John Bogle, junk bonds, low interest rates, market bubble, market clearing, military-industrial complex, money market fund, mortgage debt, new economy, Occupy movement, passive investing, Paul Samuelson, Paul Volcker talking about ATMs, Ponzi scheme, post-work, principal–agent problem, profit motive, proprietary trading, prudent man rule, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, seminal paper, shareholder value, short selling, South Sea Bubble, statistical arbitrage, stock buybacks, survivorship bias, The Wealth of Nations by Adam Smith, transaction costs, two and twenty, Vanguard fund, William of Occam, zero-sum game

Creating Value versus Subtracting Value In yet another distortion aided and abetted by our financial system, too many of the best and brightest young people in our land, instead of becoming scientists, physicians, educators, or public servants, are attracted by the staggering financial incentives offered in the investment industry. These massive rewards serve to divert vital human resources from other, often more productive and socially useful, pursuits. Even in the field of engineering, “financial” engineering, which is essentially rent-seeking in nature, holds sway over “real” engineering—civil, electrical, mechanical, aeronautical, and so on—which is essentially value-creating. The long-term consequences of these trends simply cannot be favorable to our nation’s wealth, growth, productivity, and global competitiveness.

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The desideratum is steady earnings growth—manage it to at least the 12 percent level if you can—and at all costs avoid falling short of the earnings expectations at which the corporation has hinted, or whispered, or “ballparked” before the year began. If all else fails, obscure the real results by merging, raising assumptions for future returns on the pension fund, taking a big one-time write-off, or accelerating the booking of orders for goods. All of this creative financial engineering apparently serves to inflate stock prices, to enrich managers, and to deliver to institutional investors what they want. But if the stock market is to be the arbiter of value, it will do its job best, in my judgment, if it sets its valuations based on punctiliously accurate corporate financial reporting and a focus on the long-term prospects of the corporations it values.

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The Financial Press With a few wonderful exceptions, journalists and business-page editors failed to adequately consider the smoke that was forming and would culminate in the financial firestorm of 2008–2009. Perhaps it would have required too much tedious digging. Perhaps the machinations were simply too complicated. Perhaps our financial engineers were clever enough to hide what they were cooking up. Less understandable, however, is the fixation of financial journalism on the momentary movements of the stock market, in which every sudden rise or fall is treated as a newsworthy event, even though the trading activity merely reflects the transfer of stock ownership from one investor to another.

Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever by Robin Wigglesworth

Albert Einstein, algorithmic trading, asset allocation, Bear Stearns, behavioural economics, Benoit Mandelbrot, Big Tech, Black Monday: stock market crash in 1987, Blitzscaling, Brownian motion, buy and hold, California gold rush, capital asset pricing model, Carl Icahn, cloud computing, commoditize, coronavirus, corporate governance, corporate raider, COVID-19, data science, diversification, diversified portfolio, Donald Trump, Elon Musk, Eugene Fama: efficient market hypothesis, fear index, financial engineering, fixed income, Glass-Steagall Act, Henri Poincaré, index fund, industrial robot, invention of the wheel, Japanese asset price bubble, Jeff Bezos, Johannes Kepler, John Bogle, John von Neumann, Kenneth Arrow, lockdown, Louis Bachelier, machine readable, money market fund, Myron Scholes, New Journalism, passive investing, Paul Samuelson, Paul Volcker talking about ATMs, Performance of Mutual Funds in the Period, Peter Thiel, pre–internet, RAND corporation, random walk, risk-adjusted returns, road to serfdom, Robert Shiller, rolodex, seminal paper, Sharpe ratio, short selling, Silicon Valley, sovereign wealth fund, subprime mortgage crisis, the scientific method, transaction costs, uptick rule, Upton Sinclair, Vanguard fund

But I hope I have written a book that does justice to the magnitude of the story I wanted to tell. As we shall see over the following chapters, this is a revolution whose seeds were sown in Belle Époque Paris, first harvested in boho San Francisco, and transformed into a world-conquering invention by Wall Street’s financial engineers. It features a colorful cast of former farmhands turned computer geeks, amateur jazz musicians, former seminarians, fallen academics, avuncular acoustic physicists, a charismatic secretary turned CEO, finance industry titans, and even a brief cameo from the Terminator. They faced enormous hurdles, public lack of interest, and often widespread scorn from the investment world’s haughty mainstream.

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During his travels around the Pacific, he had appreciated the efficiency of how traders would buy and sell warehouse receipts of commodities, rather than the more cumbersome physical vats of coconut oil, barrels of crude, or ingots of gold. This opened up a panoply of opportunities for creative financial engineers. “You store a commodity and you get a warehouse receipt and you can finance on that warehouse receipt. You can sell it, do a lot of things with it. Because you don’t want to be moving the merchandise back and forth all the time, so you keep it in place and you simply transfer the warehouse receipt,” he later recalled.19 Most’s ingenious idea was to, after a fashion, mimic this basic structure.

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But they can also be tied to the longevity of individual people, so it was later amended and pegged to eleven children born around 1990–93, such as Weber’s daughter Emily, who was born on the same day that SPDR was established.35 As a result, SPDR will expire either on January 22, 2118, or twenty years after the death of the last survivor of the eleven people mentioned in the trust, whichever occurs first. After a hefty internal debate, the Amex team decided against trying to patent their invention—with seismic consequences. Given SPDR’s public filings, it was easy for rivals to copy the design. Virtually anything can be put inside an ETF “warehouse,” and over the years Wall Street’s financial engineers have used the variants of the structure to create vehicles for investors to bet on everything from the US bond market to risky bank loans, African stocks, the robotics industry, and even financial volatility itself. Today, ETFs are a $9 trillion industry, and they account for about a third of all trading on US exchanges.

Mastering the Market Cycle: Getting the Odds on Your Side by Howard Marks

activist fund / activist shareholder / activist investor, Alan Greenspan, Albert Einstein, behavioural economics, business cycle, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, financial engineering, financial innovation, fixed income, Glass-Steagall Act, if you build it, they will come, income inequality, Isaac Newton, job automation, junk bonds, Long Term Capital Management, low interest rates, margin call, Michael Milken, money market fund, moral hazard, new economy, profit motive, quantitative easing, race to the bottom, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, secular stagnation, short selling, South Sea Bubble, stocks for the long run, superstar cities, The Chicago School, The Great Moderation, transaction costs, uptick rule, VA Linux, Y2K, yield curve

But borrowers were assured that, thanks to the generous capital market conditions, they would always be able to refinance into yet another mortgage, again with a sub-market teaser rate. Investment banks were eager to turn the raw material of plentiful sub-prime mortgages into tranched mortgage backed securities with the highest average credit rating, in order to maximize their salability. The ardor for this activity at just the time that “financial engineering” came into favor gave rise to ratings for tranches that turned out to have been totally divorced from how they actually would perform under stress. The investment banks that created and sold these securities often were willing to retain the equity layer at the bottom of the tranched structure in order to facilitate a high volume of issuance or simply out of a desire to hold high-yielding assets (i.e., even they were oblivious to the toxic nature of their product).

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Rather, the GFC was a largely financial phenomenon that resulted entirely from the behavior of financial players. The main forces that created this cycle were the easy availability of capital; a lack of experience and prudence sufficient to temper the unbridled enthusiasm that pervaded the process; imaginative financial engineering; the separation of lending decisions from loan retention; and irresponsibility and downright greed. It must be noted, however, that this chain reaction was abetted by elected officials who were eager to expand the American dream of home ownership and naively thought it would be great if everyone was enabled to buy a home.

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(Incentives like these—which allow participants to engage in pro-risk behavior without having to worry about the consequences—were described in the Global Financial Crisis as creating “moral hazard,” a term that came into widespread use. While it’s heard less often these days, the concept survives, and it remains dangerous.) The key to the purported success of sub-prime mortgage backed securities lay in “financial engineering” performed by “quants” and Ph.D.’s, many of them in their first jobs. They modeled risk based on the flawed assumption that mortgage defaults would remain uncorrelated and benign as in the past. The creation of large amounts of sub-prime MBS meant there was a lot of business for the rating agencies whose imprimatur was essential.

The Economics of Belonging: A Radical Plan to Win Back the Left Behind and Achieve Prosperity for All by Martin Sandbu

air traffic controllers' union, Airbnb, Alan Greenspan, autonomous vehicles, balance sheet recession, bank run, banking crisis, basic income, Berlin Wall, Bernie Sanders, Big Tech, Boris Johnson, Branko Milanovic, Bretton Woods, business cycle, call centre, capital controls, carbon footprint, carbon tax, Carmen Reinhart, centre right, collective bargaining, company town, debt deflation, deindustrialization, deskilling, Diane Coyle, Donald Trump, Edward Glaeser, eurozone crisis, Fall of the Berlin Wall, financial engineering, financial intermediation, full employment, future of work, gig economy, Gini coefficient, green new deal, hiring and firing, income inequality, income per capita, industrial robot, intangible asset, job automation, John Maynard Keynes: technological unemployment, Kenneth Rogoff, knowledge economy, knowledge worker, labour market flexibility, liquidity trap, longitudinal study, low interest rates, low skilled workers, manufacturing employment, Martin Wolf, meta-analysis, mini-job, Money creation, mortgage debt, new economy, offshore financial centre, oil shock, open economy, pattern recognition, pink-collar, precariat, public intellectual, quantitative easing, race to the bottom, Richard Florida, Robert Shiller, Robert Solow, Ronald Reagan, secular stagnation, social intelligence, TaskRabbit, total factor productivity, universal basic income, very high income, winner-take-all economy, working poor

The new communication and information technologies that have arrived like whirlwinds since the 1980s have created “winner-takes-all” dynamics in many sectors. As it has become easier for top performers to serve bigger markets—in fields from pop music and film to highly specialised services like litigation, financial engineering, and management—the market rewards for being number one rather than second best have ballooned.12 (Globalisation has added to this—but the technology that drives it would have made it happen within national economies in any case.) In some countries, and particularly clearly in the United States, this has encouraged a growing concentration of profits in the hands of a few firms in the affected sectors (most obviously technology and web services), amplified by policies that make it harder for competitors to challenge dominant firms.13 In parallel, many countries have seen the share of national income going to capital owners rising while that going to wages and salaries has fallen.

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Chapter 4 already showed the ways in which financialisation aggravates the economy’s post-industrial tendency to leave some people behind. But it does so through largely domestic mechanisms: reckless domestic bank lending creates financial instability; financialisation diverts resources away from the most productive investments; and financial engineering shifts the balance of power and the division of national income in favour of domestic capital owners over domestic workers, which also increases regional inequality. Financialisation has all these effects. But it would have them in a perfectly closed national economic system, too. This is where we come to the second accusation, which is that financial globalisation is the cause of domestic financialisation—either directly or by stunting national policymakers’ ability to regulate it (or both).

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One harmful effect of financial sophistication is to increase the ability of the managers and financiers who control the allocation of capital to extract economic value for themselves. Much of the increase in financial activity has had that function. That includes practices such as using stock market options to engineer payouts for top executives out of all proportion to the value they create;5 using financial engineering to break apart or merge companies, which on the whole does not increase productivity but generates fees for investment banks; or individualising savings that used to be implicit and collective, such as pensions provision or student funding. Similarly, the number of intermediaries in the financial chain between savers and borrowers has multiplied while there has been a general increase in financial trading—for which financiers are paid by volume, rather than for creating any underlying economic value.

Trading Risk: Enhanced Profitability Through Risk Control by Kenneth L. Grant

backtesting, business cycle, buy and hold, commodity trading advisor, correlation coefficient, correlation does not imply causation, delta neutral, diversification, diversified portfolio, financial engineering, fixed income, frictionless, frictionless market, George Santayana, global macro, implied volatility, interest rate swap, invisible hand, Isaac Newton, John Meriwether, Long Term Capital Management, managed futures, market design, Myron Scholes, performance metric, price mechanism, price stability, proprietary trading, risk free rate, risk tolerance, risk-adjusted returns, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, the scientific method, The Wealth of Nations by Adam Smith, transaction costs, two-sided market, uptick rule, value at risk, volatility arbitrage, yield curve, zero-coupon bond

As is the case elsewhere, this limitation contains a hidden opportunity: I believe it is useful to compare correlations between securities across different time spans so as to gain a better The Risk Components of an Individual Portfolio 91 understanding of interactive pricing dynamics across the fullest range of available market conditions. VALUE AT RISK (VaR) Through the efforts of modern-day financial engineers, a new paradigm has emerged: It is now possible, nay, even fashionable, to combine the concepts of volatility and correlation into a single, portfolio-based exposure estimate. This work, most of which has been conducted over the past 15 or so years, is most broadly synthesized under the heading of Value at Risk, which is now thought of as the standard methodology for risk management in the financial services industry.

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Method 1: Inverted Sharpe Ratio We’ll start the process by focusing on the less intuitive task of developing a methodology for setting a sensible lower bound for portfolio exposure. If we accept the critical notion that risk and return are interrelated, then we ought to be able to express one in units of the other. Indeed, as we have already covered, some of the most important work done in the era of financial engineering is the expression of return in units of risk. Most famously, and most relevantly for our purposes, these concepts are embodied in the Sharpe Ratio calculation, which you may recall is a ratio of returns to their associated volatility. If we can estimate our Sharpe Ratio with relative accuracy, we have a pretty good notion of the kind of return we can expect for a given level of performance volatility.

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Although, as becomes such an eclectic enterprise, LNV’s eccentric lead singer died in 1993 (yup, heroin overdose); I’m pretty sure the band is still kicking around somewhere. I hope they come to New York some time; I’d really like to catch their act. In my work at Soc Gen, I had an opportunity to interact pretty extensively with many of its principal financial engineers; and I want to tell you the story of my dealings with one such individual, a small, wiry, chain-smoking politechnician whose exact name I can’t recall, so I’ll simply refer to him as Petit. One of my missions in the bank was to negotiate with Petit and his entourage, to entreat, beseech, and otherwise plead with him to temper Justice with Mercy in the setting of certain risk parameters for a pet project of my boss’s, the details of which escape me in the fog of the years that have since passed.

The Golden Passport: Harvard Business School, the Limits of Capitalism, and the Moral Failure of the MBA Elite by Duff McDonald

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, activist fund / activist shareholder / activist investor, Affordable Care Act / Obamacare, Albert Einstein, Apollo 13, barriers to entry, Bayesian statistics, Bear Stearns, Bernie Madoff, Bob Noyce, Bonfire of the Vanities, business cycle, business process, butterfly effect, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, Carl Icahn, Clayton Christensen, cloud computing, collateralized debt obligation, collective bargaining, commoditize, compensation consultant, corporate governance, corporate raider, corporate social responsibility, creative destruction, deskilling, discounted cash flows, disintermediation, disruptive innovation, Donald Trump, eat what you kill, Fairchild Semiconductor, family office, financial engineering, financial innovation, Frederick Winslow Taylor, full employment, George Gilder, glass ceiling, Glass-Steagall Act, global pandemic, Gordon Gekko, hiring and firing, Ida Tarbell, impact investing, income inequality, invisible hand, Jeff Bezos, job-hopping, John von Neumann, Joseph Schumpeter, junk bonds, Kenneth Arrow, Kickstarter, Kōnosuke Matsushita, London Whale, Long Term Capital Management, market fundamentalism, Menlo Park, Michael Milken, new economy, obamacare, oil shock, pattern recognition, performance metric, Pershing Square Capital Management, Peter Thiel, planned obsolescence, plutocrats, profit maximization, profit motive, pushing on a string, Ralph Nader, Ralph Waldo Emerson, RAND corporation, random walk, rent-seeking, Ronald Coase, Ronald Reagan, Sam Altman, Sand Hill Road, Saturday Night Live, scientific management, shareholder value, Sheryl Sandberg, Silicon Valley, Skype, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, Steve Jurvetson, survivorship bias, TED Talk, The Nature of the Firm, the scientific method, Thorstein Veblen, Tragedy of the Commons, union organizing, urban renewal, vertical integration, Vilfredo Pareto, War on Poverty, William Shockley: the traitorous eight, women in the workforce, Y Combinator

Just before it all came crashing down, Enron shares were trading at 60 times earnings, despite it basically having turned itself into a bank, and banks tend to trade for 10 to 15 times earnings. To keep it up there, he had to keep giving the market what it wanted. It’s not easy being a winner. People start to expect things from you. 3.He gave in completely to the temptations of financial engineering, specifically off-balance-sheet financing and securitization. While you don’t need to be an investment banker to know when a financial engineering decision is being made for the wrong reasons, you probably need one to help you pull that kind of move off. Skilling wouldn’t work on Wall Street, but he’d work with them, just for this one thing. To ramp up growth on paper, he turned Enron into a company without enough assets to sustain the debt that had been piled on top of them.

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He even ventured into the coining of aphorisms, some of which were essentially truisms (“An average idea in the hands of an able man is worth much more than an outstanding idea in the possession of a person with only average ability”) but others of enduring insight (“Be wary of investment bankers; they’ve got a totally different view of the world,” and “Somebody, somewhere, is designing a product that will make your product obsolete”). Georges Doriot was also one of a long string of HBS professors who stressed the importance of understanding everything about a company. Whereas later generations of Harvard MBAs emerged from the School understanding little more than their desire to use financial engineering in order to become rich, Doriot demanded that his students study not just a company’s inputs and outputs, but the relationships that made it work as well. “He had more influence on what has happened in American business than the rest of the Harvard faculty put together,”14 said Zalman Bernstein, founder and chairman of Sanford Bernstein & Company. 14 A Decade in Review: 1930–1939 In 1915, the New York Times ran an editorial in support of college-educated businessmen: “We are confident that the young man with a college education is better fitted for advancement in modern business than the one who begins at the foot of the ladder with small learning.”

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Revelations that the legendary cost-cutting chief of GE was enjoying some $2.5 million a year in retirement perks that included free flowers, wine, and even vitamins flew in the face of his reputation, and he relinquished them under the glare of criticism.20 His record as CEO of General Electric was also being dissected, and his once-heralded ability to “manage” earnings decried as financial engineering that skated too close to the edge. His successor at the helm of GE, Jeffrey Immelt (’82), even felt compelled to clarify that “[w]e manage businesses, not earnings.” This imbroglio destabilized what at that point had become a $100 million a year arm of the HBS operation.21 But not for long.

The Man Who Broke Capitalism: How Jack Welch Gutted the Heartland and Crushed the Soul of Corporate America—and How to Undo His Legacy by David Gelles

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, 3D printing, accounting loophole / creative accounting, Adam Neumann (WeWork), air traffic controllers' union, Alan Greenspan, Andrei Shleifer, Bear Stearns, benefit corporation, Bernie Sanders, Big Tech, big-box store, Black Monday: stock market crash in 1987, Boeing 737 MAX, call centre, carbon footprint, Carl Icahn, collateralized debt obligation, Colonization of Mars, company town, coronavirus, corporate governance, corporate raider, corporate social responsibility, COVID-19, Credit Default Swap, credit default swaps / collateralized debt obligations, disinformation, Donald Trump, financial deregulation, financial engineering, fulfillment center, gig economy, global supply chain, Gordon Gekko, greed is good, income inequality, inventory management, It's morning again in America, Jeff Bezos, junk bonds, Kaizen: continuous improvement, Kickstarter, Lean Startup, low interest rates, Lyft, manufacturing employment, Mark Zuckerberg, Michael Milken, Neil Armstrong, new economy, operational security, profit maximization, profit motive, public intellectual, QAnon, race to the bottom, Ralph Nader, remote working, Robert Bork, Ronald Reagan, Rutger Bregman, self-driving car, shareholder value, side hustle, Silicon Valley, six sigma, Social Responsibility of Business Is to Increase Its Profits, Steve Ballmer, stock buybacks, subprime mortgage crisis, TaskRabbit, technoutopianism, Travis Kalanick, Uber and Lyft, uber lyft, warehouse robotics, Watson beat the top human players on Jeopardy!, We are the 99%, WeWork, women in the workforce

The collectivist spirit of the postwar years might have helped create the great American middle class, but such idealistic conceptions of business’s role in society were no roadmap for success in the hypercompetitive economy of the 1980s. Welch foresaw a different future for GE, one defined not by electric light bulbs, but by quarterly earnings; one powered not by mechanical engineering, but by financial engineering. Speaking to a room full of analysts from research firms and banks—the people who told investors whether or not to buy GE stock—Welch dispensed with the usual business of describing the company’s financial results. Instead, in twenty minutes, he laid out his vision for the future. Titled “Growing Fast in a Slow-Growth Economy,” the speech depicted a winner-take-all world, where companies were either dominating their industry or sliding into irrelevance.

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At the very moment he was selling off some of GE’s signature businesses—air-conditioning and small appliances—he was gobbling up companies that had nothing to do with manufacturing. Soon after those deals, he acquired Kidder Peabody. He was laying the groundwork for the most radical transformation GE would experience under his leadership: its evolution from a company that relied on its industrial prowess to one that depended on financial engineering. During his first decade in charge, Welch grew GE Capital at a modest clip. When he took over, the unit had $11 billion in assets. A decade later, it had $70 billion in assets, and had expanded its operations from the United States to other countries as well. Kidder Peabody, problematic as it was, had given GE a foothold on Wall Street.

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Dave Cote, a senior GE executive who was among the final half dozen candidates to succeed Welch, went on to have a strong run at Honeywell after Bossidy left. Over more than a decade, Cote emerged as a durable leader who oversaw sustained growth in his company’s core business, without resorting to massive layoffs or financial engineering. Honeywell stock soared during his tenure, making him one of the few Welch protégés to deliver sustained growth for investors. Another Welch disciple, Omar Ishrak, left GE after feeling like he didn’t have the support to innovate and develop new products, according to Bill George, who recruited Ishrak to Medtronic, the medical device maker.

The Trade Lifecycle: Behind the Scenes of the Trading Process (The Wiley Finance Series) by Robert P. Baker

asset-backed security, bank run, banking crisis, Basel III, Black-Scholes formula, book value, Brownian motion, business continuity plan, business logic, business process, collapse of Lehman Brothers, corporate governance, credit crunch, Credit Default Swap, diversification, financial engineering, fixed income, functional programming, global macro, hiring and firing, implied volatility, interest rate derivative, interest rate swap, locking in a profit, London Interbank Offered Rate, low interest rates, margin call, market clearing, millennium bug, place-making, prediction markets, proprietary trading, short selling, statistical model, stochastic process, the market place, the payments system, time value of money, too big to fail, transaction costs, value at risk, Wiener process, yield curve, zero-coupon bond

Some swift political intervention was required to overcome this obstacle. The credit event feeder system was canned due to unreliability so the project was diverted to taking this data from Bloomberg. The financial engineering team who wrote the calculation engine and a few other mathematical tools used by RABOND finished long before the IT team. This meant that by the time the system was ready for full testing, the financial engineers were 234 THE TRADE LIFECYCLE on other projects and had to re-acquaint themselves with code they had forgotten in order to provide specialist help or fix bugs. There were a series of credit events just after the project went live.

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Like most banks, Rabobank held a large portfolio of bonds and was active in hedging using credit default swaps (CDS). The fixed income desk was a very important component of the London-based Capital Markets division. The desk comprised traders, structurers, salespeople, middle and back office and a dedicated quantitative team of financial engineers drawing resources from a global pool of IT staff. 225 226 THE TRADE LIFECYCLE Project background This case study features a problem that existed in the bank in the mid-2000s. Bonds were being booked into multiple systems depending on their type. It was very hard to identify them for reporting and management information and for any consolidated view of the entire portfolio.

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Case Studies 227 There were also reasons why they perceived RABOND as being negative from a trading perspective. They were concerned that having a system to accurately measure credit and bond exposures might focus attention on this area and negatively impact their trading limits. They needed the financial engineering team (who were primarily behind RABOND) for other projects. Historically traders had never had much communication with the IT department. Taken together, this meant that the project manager for RABOND had to steer a path away from the traders, only involving them where absolutely necessary.

A Man for All Markets by Edward O. Thorp

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", 3Com Palm IPO, Alan Greenspan, Albert Einstein, asset allocation, Bear Stearns, beat the dealer, Bernie Madoff, Black Monday: stock market crash in 1987, Black Swan, Black-Scholes formula, book value, Brownian motion, buy and hold, buy low sell high, caloric restriction, caloric restriction, carried interest, Chuck Templeton: OpenTable:, Claude Shannon: information theory, cognitive dissonance, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Edward Thorp, Erdős number, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, Garrett Hardin, George Santayana, German hyperinflation, Glass-Steagall Act, Henri Poincaré, high net worth, High speed trading, index arbitrage, index fund, interest rate swap, invisible hand, Jarndyce and Jarndyce, Jeff Bezos, John Bogle, John Meriwether, John Nash: game theory, junk bonds, Kenneth Arrow, Livingstone, I presume, Long Term Capital Management, Louis Bachelier, low interest rates, margin call, Mason jar, merger arbitrage, Michael Milken, Murray Gell-Mann, Myron Scholes, NetJets, Norbert Wiener, PalmPilot, passive investing, Paul Erdős, Paul Samuelson, Pluto: dwarf planet, Ponzi scheme, power law, price anchoring, publish or perish, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, RFID, Richard Feynman, risk-adjusted returns, Robert Shiller, rolodex, Sharpe ratio, short selling, Silicon Valley, Stanford marshmallow experiment, statistical arbitrage, stem cell, stock buybacks, stocks for the long run, survivorship bias, tail risk, The Myth of the Rational Market, The Predators' Ball, the rule of 72, The Wisdom of Crowds, too big to fail, Tragedy of the Commons, uptick rule, Upton Sinclair, value at risk, Vanguard fund, Vilfredo Pareto, Works Progress Administration

Companies came with families of securities, which included convertible bonds and preferreds, warrants, and put and call options. These derived most of their value from that of the underlying stock and were called derivatives. They proliferated in number, type, and quantity in the decades to follow, as so-called financial engineers invented new ones to possibly decrease risk and certainly increase fees. I used my methodology to price these derivatives and the others that followed. This enabled Princeton Newport Partners to price convertible bonds more accurately than anyone else. Hedging with derivatives was a key source of profits for PNP during its entire nineteen years.

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But if I did that, then, in addition to the fun parts, I would be responsible for things I didn’t enjoy. I changed my mind and gradually wound down our PNP office in Newport Beach, finding good jobs in the securities industry for some of our key people at places like the giant hedge fund D. E. Shaw, the financial engineering firm Barra, and the investment group running the multibillion-dollar pension and profit sharing plan at Weyerhaeuser. Then I called Fischer Black, who was now at Goldman Sachs, after hearing that he wanted to build a computerized analytic system for trading warrants and, especially, convertible bonds.

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The hedge fund Long-Term Capital Management was launched in 1994 with a dream team of sixteen general partners, led by the legendary former Salomon Brothers trader John Meriwether and two future (1997) Nobel Prize winners in economics, Robert Merton and Myron Scholes. The group included other former Salomon traders, more distinguished academics, and a former Federal Reserve vice chairman. Investors included the central banks of eight countries, plus major brokerages, banks, and other institutions. The principals of a financial engineering group I knew, who were coincidentally doing work for LTCM at that time, asked if I had an interest in investing in the fund. I declined because Meriwether had a history at Salomon of being a major risk taker and the partnership’s theorists were, I believed, lacking in “street smarts” and practical investment experience.

Commodity Trading Advisors: Risk, Performance Analysis, and Selection by Greg N. Gregoriou, Vassilios Karavas, François-Serge Lhabitant, Fabrice Douglas Rouah

Asian financial crisis, asset allocation, backtesting, buy and hold, capital asset pricing model, collateralized debt obligation, commodity trading advisor, compound rate of return, constrained optimization, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, discrete time, distributed generation, diversification, diversified portfolio, dividend-yielding stocks, financial engineering, fixed income, global macro, high net worth, implied volatility, index arbitrage, index fund, interest rate swap, iterative process, linear programming, London Interbank Offered Rate, Long Term Capital Management, managed futures, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, p-value, Pareto efficiency, Performance of Mutual Funds in the Period, Ponzi scheme, proprietary trading, quantitative trading / quantitative finance, random walk, risk free rate, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, stochastic process, survivorship bias, systematic trading, tail risk, technology bubble, transaction costs, value at risk, zero-sum game

With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding. The Wiley Finance series contains books written specifically for finance and investment professionals, as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation, and financial instrument analysis, as well as much more. For a list of available titles, visit our web site at www.WileyFinance.com. Commodity Trading Advisors Risk, Performance Analysis, and Selection GREG N. GREGORIOU VASSILIOS N. KARAVAS FRANÇOIS-SERGE LHABITANT FABRICE ROUAH John Wiley & Sons, Inc.

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He is the author of four books on financial markets and has published over 60 research articles on the topics of corporate governance, hedge funds, real estate, currency overlay, credit risk, private equity, risk management, and portfolio management. Dr. Anson is on the editorial boards of five financial journals and sits on Advisory Committees for the New York Stock Exchange, the International Association of Financial Engineers, AIMR’s Task Force on Corporate Governance, the Center for Excellence in Accounting and Security Analysis at Columbia University, and the Alternative Investment Research Centre at the City University of London. Zsolt Berenyi holds an M.Sc. in Economics from the University of Budapest and a Ph.D. in Finance from the University of Munich.

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Fernando Diz is the Whitman Associate Professor of Finance at the Syracuse University Martin J. Whitman School of Management. He also has been Visiting Associate Professor of Finance at the Johnson Graduate School of Management, Cornell University, where he taught courses on derivatives and financial engineering. Professor Diz is also the Founder and President of M&E Financial Markets Research, LLC. He specializes in About the Authors xvii managed futures, money management, market volatility, and the use of derivative securities in investment and speculative portfolios as well as distress and value investing.

Mathematics of the Financial Markets: Financial Instruments and Derivatives Modelling, Valuation and Risk Issues by Alain Ruttiens

algorithmic trading, asset allocation, asset-backed security, backtesting, banking crisis, Black Swan, Black-Scholes formula, Bob Litterman, book value, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, delta neutral, discounted cash flows, discrete time, diversification, financial engineering, fixed income, implied volatility, interest rate derivative, interest rate swap, low interest rates, managed futures, margin call, market microstructure, martingale, p-value, passive investing, proprietary trading, quantitative trading / quantitative finance, random walk, risk free rate, risk/return, Satyajit Das, seminal paper, Sharpe ratio, short selling, statistical model, stochastic process, stochastic volatility, time value of money, transaction costs, value at risk, volatility smile, Wiener process, yield curve, zero-coupon bond

FABOZZI, The Mathematics of Financial Modeling and Investment Management, John Wiley & Sons, Inc., Hoboken, 2004, 800 p. Lawrence GALITZ, Financial Times Handbook of Financial Engineering, FT Press, 3rd ed. Scheduled on November 2011, 480 p. Philippe JORION, Financial Risk Manager Handbook, John Wiley & Sons, Inc., Hoboken, 5th ed., 2009, 752 p. Tze Leung LAI, Haipeng XING, Statistical Models and Methods for Financial Markets, Springer, 2008, 374 p. David RUPPERT, Statistics and Finance, An Introduction, Springer, 2004, 482 p. Dan STEFANICA, A Primer for the Mathematics of Financial Engineering, FE Press, 2011, 352 p. Robert STEINER, Mastering Financial Calculations, FT Prentice Hall, 1997, 400 p.

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Helyette GEMAN, Commodities and Commodity Derivatives – Modelling and Pricing for Agricultural, Metals and Energy, John Wiley & Sons, Ltd, Chichester, 2005, 416 p. Helyette GEMAN, Insurance and Weather Derivatives – From Exotic Options to Exotic Underlyings, RISK Books, 1999, 300 p. Espen Gaarder HAUG, The Complete Guide to Option Pricing Formulas, Irwin Professional Publishing, 1997, 232 p. Lawrence GALITZ, Financial Times Handbook of Financial Engineering, FT Press, 3rd ed., 2011, 480 p. Robert A. HAUGEN, Modern Investment Theory, Prentice Hall, 4th ed., 1996, 748 p. Peter JACKEL, Monte Carlo Methods in Finance, John Wiley & Sons, Ltd, Chichester, 2002, 222 p. Robert JARROW, Andrew RUDD, Option Pricing, Irwin, 1987, 235 p. E. JONDEAU, S.H.

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SHARPE, Investors and Markets – Portfolio Choices, Asset Prices, and Investment Advice, Princeton University Press, 2006, 232 p. Jan de SPIEGELEER, Wim SCHOUTENS, The Handbook of Convertible Bonds: Pricing, Strategies and Risk Management, John Wiley & Sons, Ltd, Chichester, 2011, 400 p. Dan STEFANICA, A Primer for the Mathematics of Financial Engineering, FE Press, 2011, 352 p. Robert STEINER, Mastering Financial Calculations, FT Prentice Hall, 1997, 400 p. Nassim TALEB, Dynamic Hedging: Managing Vanilla and Exotic Options, John Wiley & Sons, Inc., Hoboken, 1997, 506 p. Peter TANKOV, Financial Modelling with Jump Processes, Chapman and Hall, 2003, 552 p.

The Pyramid of Lies: Lex Greensill and the Billion-Dollar Scandal by Duncan Mavin

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, Adam Neumann (WeWork), air freight, banking crisis, Bernie Madoff, Big Tech, Boeing 737 MAX, Boris Johnson, Brexit referendum, British Empire, carbon footprint, coronavirus, corporate governance, COVID-19, Credit Default Swap, democratizing finance, Donald Trump, Eyjafjallajökull, financial engineering, fixed income, global pandemic, global supply chain, Gordon Gekko, Greensill Capital, high net worth, Kickstarter, lockdown, Long Term Capital Management, low interest rates, Masayoshi Son, means of production, Menlo Park, mittelstand, move fast and break things, NetJets, Network effects, Ponzi scheme, private military company, proprietary trading, remote working, rewilding, Rishi Sunak, rolodex, Silicon Valley, skunkworks, SoftBank, sovereign wealth fund, supply chain finance, Tim Haywood, Vision Fund, WeWork, work culture

For businesses looking for investment from so-called PE firms, there was so much money sloshing around. GA’s youthful European chief, Gabe Caillaux, a former Merrill Lynch banker, was already an old hand in the industry, having joined GA in 2004. He once told one of my Dow Jones colleagues in an interview that too many private equity firms relied on the ‘trick’ of financial engineering to generate returns, and that wasn’t sustainable. The implication was that you needed smarts, not just pots of cash, to make an investment pay off. Under Caillaux’s leadership, GA in Europe had a stellar track record. Several companies he’d invested in had listed their shares, netting GA enormous profits.

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Gupta scrambled to grab cash from around the GFG empire, using facilities he owned in Australia and elsewhere to raise more funds there, and then funnelling it into the European acquisition. Europe’s regulators were satisfied. Then, having bought the steelmaking facilities – in Romania, and the Czech Republic and elsewhere – for €740 million, Gupta used them to secure €2.2 billion in new loans from Greensill. And with that trick of financial engineering, he had enough to buy back the LRBs from GAM. As this dizzying alchemy was taking place, Jacob, the temporary GAM CEO, had been sweating on whether Gupta would come through on his new deadline for closing the funds in mid-July. There was little contact from Gupta or Greensill. In typical Gupta–Greensill style, the deal was arranged informally, not much more than a nod and a handshake.

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It mentioned the Credit Suisse funds specifically and noted that NMC had been less than forthcoming about the nature of these loan facilities. Block also told a colleague of mine at Dow Jones US-based investor magazine Barron’s that, ‘Accounting standards don’t really address reverse factoring . . . There’s not necessarily a standardized way to report. That’s the whole point of financial engineering, to take something that’s not flattering and to hide it.’ Greensill had loaned NMC $137 million from the Credit Suisse funds. NMC was eventually placed into administration and revealed that debts of $2.7 billion had not previously been reported. (There was another oddity about NMC. Companies linked to its founder, Indian businessman B.R.

The Wisdom of Finance: Discovering Humanity in the World of Risk and Return by Mihir Desai

activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, AOL-Time Warner, assortative mating, Benoit Mandelbrot, book value, Brownian motion, capital asset pricing model, Carl Icahn, carried interest, Charles Lindbergh, collective bargaining, corporate governance, corporate raider, discounted cash flows, diversified portfolio, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, follow your passion, George Akerlof, Gordon Gekko, greed is good, housing crisis, income inequality, information asymmetry, Isaac Newton, Jony Ive, Kenneth Rogoff, longitudinal study, Louis Bachelier, low interest rates, Monty Hall problem, moral hazard, Myron Scholes, new economy, out of africa, Paul Samuelson, Pierre-Simon Laplace, principal–agent problem, Ralph Waldo Emerson, random walk, risk/return, Robert Shiller, Ronald Coase, short squeeze, Silicon Valley, Steve Jobs, Thales and the olive presses, Thales of Miletus, The Market for Lemons, The Nature of the Firm, The Wealth of Nations by Adam Smith, Tim Cook: Apple, tontine, transaction costs, vertical integration, zero-sum game

Guess who provided funds to the French government by buying annuities? Unsurprisingly, old people didn’t take up the offer, but young people flocked to it—precisely those who would be the most expensive annuitants for the French government. It gets better. In probably the earliest example of financial engineers bringing havoc to the world, a group of Swiss bankers bought annuities on behalf of groups of Swiss five-year-old girls who were found to come from particularly healthy stock. They then allowed people to invest in portfolios of these annuities, in what is likely the earliest example of securitization.

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This transaction is the essence of an options transaction—relatively small premia are paid to secure the rights to enter into transactions rather than obligating someone to do something, thereby enabling them to access resources they might need but don’t know if they will need. A stock option, for example, allows you the right to buy a share at a predetermined price at some point in the future for a relatively small price today. Options, which today are sometimes regarded as esoteric manifestations of financial engineering, are as old as any traded financial instrument. When trading of financial instruments truly began, in Amsterdam in the late seventeenth century, options were a dominant instrument. Joseph de la Vega, in Confusion de Confusiones, highlighted the importance of options. In a dialogue between the philosopher and the shareholder, the philosopher is intrigued by financial markets but is concerned that he won’t be able to participate given his poverty and the fact that nobody will “lend me money on my beard.”

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Dowries (payments from a bride’s family to a groom’s) were a dominant social institution in Florence, and Francesca shows me numerous archival records of all the dowries paid in Florence in the fifteenth and sixteenth centuries. The importance of marriages and dowries gave rise, along with other circumstances, to the Dowry Fund. The Dowry Fund—an early feat of financial engineering—solved three seemingly unrelated problems. First, parents of daughters were faced with a marriage market where young women significantly outnumbered eligible older men, in part due to the plague. As one reflection of this, dowries were escalating in price rapidly, creating more risk for fathers and their daughters.

Corporate Finance: Theory and Practice by Pierre Vernimmen, Pascal Quiry, Maurizio Dallocchio, Yann le Fur, Antonio Salvi

"Friedman doctrine" OR "shareholder theory", accelerated depreciation, accounting loophole / creative accounting, active measures, activist fund / activist shareholder / activist investor, AOL-Time Warner, ASML, asset light, bank run, barriers to entry, Basel III, Bear Stearns, Benoit Mandelbrot, bitcoin, Black Swan, Black-Scholes formula, blockchain, book value, business climate, business cycle, buy and hold, buy low sell high, capital asset pricing model, carried interest, collective bargaining, conceptual framework, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, currency risk, delta neutral, dematerialisation, discounted cash flows, discrete time, disintermediation, diversification, diversified portfolio, Dutch auction, electricity market, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, eurozone crisis, financial engineering, financial innovation, fixed income, Flash crash, foreign exchange controls, German hyperinflation, Glass-Steagall Act, high net worth, impact investing, implied volatility, information asymmetry, intangible asset, interest rate swap, Internet of things, inventory management, invisible hand, joint-stock company, joint-stock limited liability company, junk bonds, Kickstarter, lateral thinking, London Interbank Offered Rate, low interest rates, mandelbrot fractal, margin call, means of production, money market fund, moral hazard, Myron Scholes, new economy, New Journalism, Northern Rock, performance metric, Potemkin village, quantitative trading / quantitative finance, random walk, Right to Buy, risk free rate, risk/return, shareholder value, short selling, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, Steve Jobs, stocks for the long run, supply-chain management, survivorship bias, The Myth of the Rational Market, time value of money, too big to fail, transaction costs, value at risk, vertical integration, volatility arbitrage, volatility smile, yield curve, zero-coupon bond, zero-sum game

Chapter 37: Distribution in practice: dividends and share buy-backs Section 37.1 Dividends Section 37.2 Exceptional dividends, share buy-backs and capital reduction Section 37.3 The choice between dividends, share buy-backs and capital reduction Chapter 38: Share issues Section 38.1 A definition of a share issue Section 38.2 Share issues and finance theory Section 38.3 Current and new shareholders Section 38.4 Share issues and accounting criteria Part Three: Debt capital Chapter 39: Implementing a debt policy Section 39.1 Debt structure Section 39.2 Covenants Section 39.3 Renegotiating debt Section 39.4 Why keep cash on the balance sheet? Section 39.5 The levers of a good debt policy Section V: Financial management Part One: Corporate governance and financial engineering Chapter 40: Setting up a company or financing start-ups Section 40.1 Financial particularities of the company being set up Section 40.2 Some basic principles for financing a start-up Section 40.3 Investors in start-ups Section 40.4 The organisation of relationships between the entrepreneur and the financial investors Section 40.5 The financial management of a start-up Section 40.6 The particularities of valuing young companies Section 40.7 Example inspired by a real case: Example.com Chapter 41: Choice of corporate structure Section 41.1 Shareholder structure Section 41.2 How to strengthen control over a company Section 41.3 Organising a diversified group Section 41.4 Financial securities’ discounts Chapter 42: Initial public offerings (IPOs) Section 42.1 To be or not to be listed?

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The shareholder can realise his investment only by selling it to someone else. The investor obtains certain corporate rights, however: a claim on the company’s earnings and – via his voting rights – management oversight. (c) Other securities (Chapter 24) As you will discover in Chapter 24, financial engineering specialists have invented hybrid securities that combine the characteristics of the two categories discussed above. Some securities have the look and feel of equity from the point of view of the company, but the corresponding cash flows are fixed, at least partially. Others instruments have yields that are dependent on the performance of the company, but are considered loans, not equity capital.

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Followed by the major financial decisions of the firm, viewed in the light of both market theory and organisational theory (Section IV: Corporate financial policies). Finally, if you persevere through the foregoing, you will get to taste the dessert, as Section V: Financial management presents several practical, current topics in financial engineering and management. Summary The summary of this chapter can be downloaded from www.vernimmen.com. The financial manager has three main roles: To ensure the company has enough funds to finance its expansion and meet its obligations. To do this, the company issues securities (equity and debt) and the financial manager sells them to financial investors at the highest possible price.

Cryptoassets: The Innovative Investor's Guide to Bitcoin and Beyond: The Innovative Investor's Guide to Bitcoin and Beyond by Chris Burniske, Jack Tatar

Airbnb, Alan Greenspan, altcoin, Alvin Toffler, asset allocation, asset-backed security, autonomous vehicles, Bear Stearns, bitcoin, Bitcoin Ponzi scheme, blockchain, Blythe Masters, book value, business cycle, business process, buy and hold, capital controls, carbon tax, Carmen Reinhart, Clayton Christensen, clean water, cloud computing, collateralized debt obligation, commoditize, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, disintermediation, distributed ledger, diversification, diversified portfolio, Dogecoin, Donald Trump, Elon Musk, en.wikipedia.org, Ethereum, ethereum blockchain, fiat currency, financial engineering, financial innovation, fixed income, Future Shock, general purpose technology, George Gilder, Google Hangouts, high net worth, hype cycle, information security, initial coin offering, it's over 9,000, Jeff Bezos, Kenneth Rogoff, Kickstarter, Leonard Kleinrock, litecoin, low interest rates, Marc Andreessen, Mark Zuckerberg, market bubble, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Network effects, packet switching, passive investing, peer-to-peer, peer-to-peer lending, Peter Thiel, pets.com, Ponzi scheme, prediction markets, quantitative easing, quantum cryptography, RAND corporation, random walk, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, Robert Shiller, Ross Ulbricht, Salesforce, Satoshi Nakamoto, seminal paper, Sharpe ratio, Silicon Valley, Simon Singh, Skype, smart contracts, social web, South Sea Bubble, Steve Jobs, transaction costs, tulip mania, Turing complete, two and twenty, Uber for X, Vanguard fund, Vitalik Buterin, WikiLeaks, Y2K

ETFS AND MUTUAL FUNDS ARE WRAPPERS, NOT ASSET CLASSES It should be noted that when we talk about asset classes we are not doing so in the context of the investment vehicle that may “house” the underlying asset, whether that vehicle is a mutual fund, ETF, or separately managed account. With the growth of financial engineering and securitization of nearly every asset—and especially with the growing popularity of ETFs—one may find every type of asset at some point housed within an ETF. For example, ETFs for bitcoin and ether are already in the filing process with the SEC. For the purpose of our definition of asset classes, we are distinguishing the asset class from the form within which they are traded.

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Every bubble by definition deflates.”27 “THIS TIME IS DIFFERENT” When asset markets are taken over by mass speculation and prices reach nosebleed territory, a common refrain can often be heard: “This time is different.” Typically, the logic goes that the markets have evolved from more primitive years, and financial engineering innovations have led to robust markets that can’t possibly crash. Time and again this thesis has been refuted by subsequent market crashes. In their well-regarded book This Time Is Different: Eight Centuries of Financial Folly, Carmen Reinhart and Kenneth Rogoff deliver a 300-page tour de force to prove that this time is never different.

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About 80 years after Tulipmania, in the early 1700s, the first international bull market came to rise.16 Kick-started by infamous entities such as John Law’s Mississippi Company in France and John Blunt’s South Sea Company in Britain, the equity markets were whipped into a buying frenzy fueled largely by duplicity. Both the Mississippi Company and South Sea Company had convoluted structures and were heavily marketed as pursuits to establish a presence and exploit trade in the burgeoning Americas, even though they had only marginal success in doing so. Both Blunt and Law used elaborate and unproven financial engineering to advance the price of their companies’ stocks at all costs. Law’s scheme was particularly intricate and dangerous, as it involved controlling France’s first central bank, in addition to the Mississippi Company, which was the country’s largest enterprise. Law won his way into a place of financial power in France with promises to resolve the country’s financial woes, which were dire: the government was on the verge of its third bankruptcy in less than a century.

Bean Counters: The Triumph of the Accountants and How They Broke Capitalism by Richard Brooks

"World Economic Forum" Davos, accounting loophole / creative accounting, Alan Greenspan, asset-backed security, banking crisis, Bear Stearns, Big bang: deregulation of the City of London, blockchain, BRICs, British Empire, business process, Charles Babbage, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Strachan, Deng Xiaoping, Donald Trump, double entry bookkeeping, Double Irish / Dutch Sandwich, energy security, Etonian, eurozone crisis, financial deregulation, financial engineering, Ford Model T, forensic accounting, Frederick Winslow Taylor, G4S, Glass-Steagall Act, high-speed rail, information security, intangible asset, Internet of things, James Watt: steam engine, Jeremy Corbyn, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, junk bonds, light touch regulation, Long Term Capital Management, low cost airline, new economy, Northern Rock, offshore financial centre, oil shale / tar sands, On the Economy of Machinery and Manufactures, Ponzi scheme, post-oil, principal–agent problem, profit motive, race to the bottom, railway mania, regulatory arbitrage, risk/return, Ronald Reagan, Savings and loan crisis, savings glut, scientific management, short selling, Silicon Valley, South Sea Bubble, statistical model, supply-chain management, The Chicago School, too big to fail, transaction costs, transfer pricing, Upton Sinclair, WikiLeaks

‘They were out of control, and they didn’t even know it because it was so cool to associate yourself with the top, with the guys who run a multi-billion-dollar company.’36 Many moved through a well-oiled revolving door into Enron jobs laden with stock options and other perks. But it was at the top that the relationship was particularly close. As Fastow turned up the financial-engineering dial, Andersen chose as its new lead audit partner for Enron 35-year-old David Duncan, described in profiles as impeccably polite and non-confrontational. A later court case heard he was a ‘client-pleaser’.37 He had become a partner only two years earlier, but was thought the right man for this major account because he was friendly with Enron’s chief accounting officer (and former Andersen auditor) Rick Causey.

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A few months later, this senior citizen received an answer, possibly because she was the Queen of the United Kingdom, from some of the most eminent brains in the land. The British Academy gathered thirty intellectuals, central bankers and assorted great-and-good and identified some now widely accepted causes: an expansion of credit in response to a largely Chinese savings glut; financial engineering magnifying and hiding risks within the ensuing credit bubble; lax financial regulation; skewed and excessive incentives for bankers, and political indulgence of their methods. Overall, they said, there was a ‘psychology of denial’ and it was ‘difficult to recall a greater example of wishful thinking combined with hubris’.

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‘These management consultants are just making money out of suckers,’ harrumphed former Chancellor Denis Healey.) In government the following year, the appeal of the consultants to New Labour was twofold. They were more malleable than civil servants, who, Blair would claim a couple of years later, blocked change and inflicted ‘scars on his back’. And, of more immediate value, they were adept at the financial engineering of which he and his Chancellor Gordon Brown had urgent need. PRIVATE PARTY Central to New Labour’s election victory was renouncing high taxes and committing to sound public finances. These twin new commitments were enshrined in a self-imposed limit on government debt. But the party had also distinguished itself from the Tories by promising to improve public services that had been starved of investment.

Don't Be Evil: How Big Tech Betrayed Its Founding Principles--And All of US by Rana Foroohar

"Susan Fowler" uber, "World Economic Forum" Davos, accounting loophole / creative accounting, Airbnb, Alan Greenspan, algorithmic bias, algorithmic management, AltaVista, Andy Rubin, autonomous vehicles, banking crisis, barriers to entry, behavioural economics, Bernie Madoff, Bernie Sanders, Big Tech, bitcoin, Black Lives Matter, book scanning, Brewster Kahle, Burning Man, call centre, Cambridge Analytica, cashless society, clean tech, cloud computing, cognitive dissonance, Colonization of Mars, computer age, corporate governance, creative destruction, Credit Default Swap, cryptocurrency, data is the new oil, data science, deal flow, death of newspapers, decentralized internet, Deng Xiaoping, digital divide, digital rights, disinformation, disintermediation, don't be evil, Donald Trump, drone strike, Edward Snowden, Elon Musk, en.wikipedia.org, Erik Brynjolfsson, Etonian, Evgeny Morozov, fake news, Filter Bubble, financial engineering, future of work, Future Shock, game design, gig economy, global supply chain, Gordon Gekko, Great Leap Forward, greed is good, income inequality, independent contractor, informal economy, information asymmetry, intangible asset, Internet Archive, Internet of things, invisible hand, Jaron Lanier, Jeff Bezos, job automation, job satisfaction, junk bonds, Kenneth Rogoff, life extension, light touch regulation, low interest rates, Lyft, Mark Zuckerberg, Marshall McLuhan, Martin Wolf, Menlo Park, military-industrial complex, move fast and break things, Network effects, new economy, offshore financial centre, PageRank, patent troll, Paul Volcker talking about ATMs, paypal mafia, Peter Thiel, pets.com, price discrimination, profit maximization, race to the bottom, recommendation engine, ride hailing / ride sharing, Robert Bork, Sand Hill Road, search engine result page, self-driving car, shareholder value, sharing economy, Sheryl Sandberg, Shoshana Zuboff, side hustle, Sidewalk Labs, Silicon Valley, Silicon Valley startup, smart cities, Snapchat, SoftBank, South China Sea, sovereign wealth fund, Steve Bannon, Steve Jobs, Steven Levy, stock buybacks, subscription business, supply-chain management, surveillance capitalism, TaskRabbit, tech billionaire, tech worker, TED Talk, Telecommunications Act of 1996, The Chicago School, the long tail, the new new thing, Tim Cook: Apple, too big to fail, Travis Kalanick, trickle-down economics, Uber and Lyft, Uber for X, uber lyft, Upton Sinclair, warehouse robotics, WeWork, WikiLeaks, zero-sum game

Stiglitz, who heads up the Independent Commission for the Reform of International Corporate Taxation, a group of academics and policy makers pushing for global tax reform. “Firms like this can use financial engineering to play all sorts of games,” says Stiglitz, who favors a global flat tax on such firms to avoid a zero-sum race to the bottom to the lowest-cost tax havens.9 How would this actually work in practice? A key idea found in many of the proposals from tax reform advocates is to tax revenues at the point of sale, rather than profits, which would reduce the sort of financial engineering that allows IP- and data-rich companies like Apple and Google to offshore profits in tax havens like Ireland and the Netherlands.

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But hidden within these bullish headlines are a number of disturbing economic trends of which Apple is already an exemplar. Study this one company, and you begin to understand how Big Tech companies—the new too-big-to-fail institutions—could indeed sow the seeds of the next crisis. * * * — THE FIRST THING to consider is the financial engineering done by such firms. Like most of the largest and most profitable multinational companies, Apple has loads of cash—$285 billion—as well as plenty of debt (close to $122 billion). That is because—like nearly every other large, rich company—it has parked most of its spare cash in offshore bond portfolios over the past ten years.

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Or, as my Financial Times colleague Martin Wolf has put it, “[Apple] is now an investment fund attached to an innovation machine and so a black hole for aggregate demand. The idea that a lower corporate tax rate would raise investment in such businesses is ludicrous.”19 In short, cash-rich corporations—especially tech firms—have become the financial engineers of our day.20 The House Always Wins There are the ways in which Big Tech is driving the mega-trends in global markets, as we’ve just explored. Then, there are the ways tech companies are playing in those markets that grant them an unfair advantage over consumers. For example, Google, Facebook, and increasingly Amazon now own the digital advertising market, and can set whatever terms they like for customers.

Crashed: How a Decade of Financial Crises Changed the World by Adam Tooze

"there is no alternative" (TINA), "World Economic Forum" Davos, Affordable Care Act / Obamacare, Alan Greenspan, Apple's 1984 Super Bowl advert, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, Berlin Wall, Bernie Sanders, Big bang: deregulation of the City of London, bond market vigilante , book value, Boris Johnson, bread and circuses, break the buck, Bretton Woods, Brexit referendum, BRICs, British Empire, business cycle, business logic, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, collateralized debt obligation, company town, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, currency risk, dark matter, deindustrialization, desegregation, Detroit bankruptcy, Dissolution of the Soviet Union, diversification, Doha Development Round, Donald Trump, Edward Glaeser, Edward Snowden, en.wikipedia.org, energy security, eurozone crisis, Fall of the Berlin Wall, family office, financial engineering, financial intermediation, fixed income, Flash crash, forward guidance, friendly fire, full employment, global reserve currency, global supply chain, global value chain, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, high-speed rail, housing crisis, Hyman Minsky, illegal immigration, immigration reform, income inequality, interest rate derivative, interest rate swap, inverted yield curve, junk bonds, Kenneth Rogoff, large denomination, light touch regulation, Long Term Capital Management, low interest rates, margin call, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, military-industrial complex, mittelstand, money market fund, moral hazard, mortgage debt, mutually assured destruction, negative equity, new economy, Nixon triggered the end of the Bretton Woods system, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shale / tar sands, old-boy network, open economy, opioid epidemic / opioid crisis, paradox of thrift, Peter Thiel, Ponzi scheme, Post-Keynesian economics, post-truth, predatory finance, price stability, private sector deleveraging, proprietary trading, purchasing power parity, quantitative easing, race to the bottom, reserve currency, risk tolerance, Ronald Reagan, Savings and loan crisis, savings glut, secular stagnation, Silicon Valley, South China Sea, sovereign wealth fund, special drawing rights, Steve Bannon, structural adjustment programs, tail risk, The Great Moderation, Tim Cook: Apple, too big to fail, trade liberalization, upwardly mobile, Washington Consensus, We are the 99%, white flight, WikiLeaks, women in the workforce, Works Progress Administration, yield curve, éminence grise

Leaving behind the GSE-centered model of the 1990s, they deprioritized conforming mortgages in favor of private label “unconventional” lending—subprime, slightly better Alt-A and oversized jumbo loans. What the private issuers discovered was that if scrutinizing conventional mortgages was profitable, subprime was even more so.40 The financial engineering was more elaborate and one could charge more money for the services. The techniques of the fixed-income investment bankers were now brought fully into play. A surprisingly large share even of nonconforming private label MBS could still attract an AAA rating once combined in structured products.

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What they did not pay attention to, because they did not dirty their hands with technicalities like MBS, was the effect the influx of emerging market funds might have in financial markets. Emerging market investors bought first Treasurys and then GSE-issued agency debt. This left other institutional investors looking for alternatives. What filled the gap was financial engineering. If pension funds, life insurers and the managers of the gigantic cash pools accumulated by profitable corporations and the ultrawealthy needed safe assets, AAA-rated securities were a product America’s mortgage machine knew how to synthesize. Foreign Reserves and Institutional Investors Compete for US Short-Term Safe Assets (in $ billions) Outstanding Amounts: 2005 2006 2007 2008 2009 2010 Short-term Treasury securities* 1,146 1,173 1,192 1,909 2,558 2,487 Short-term agency securities** 568 489 560 903 844 618 Total 1,714 1,662 1,752 2,812 3,402 3,105 (−) Foreign Official Holdings: Short-term Treasury securities 216 193 181 273 562 na Short-term agency securities 112 110 80 130 34 na Total 328 303 261 403 596 na (−) Demand from Institutional Cash Pools: Institutional cash pools (based on available data) 1,771 2,120 2,216 1,834 2,041 1,911 Institutional cash pools (estimate of total volume) 3,120 3,735 3,852 3,467 3,596 3,432 Average 2,445 2,927 3,034 2,650 2,818 2,672 = Deficit of safe, liquid, short-term products (1,059) (1,568) (1,543) (241) (12) na *Includes Treasury bills and Treasury securities with a remaining maturity of one year or less.

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The commonplace recommendation to tighten fiscal policy might have helped. But this pointed the finger away from where the stress really was, in the financial system. Indeed, from the point of view of financial stability it might have been desirable if more of the AAA securities in circulation had been genuine US government debt rather than the products of financial engineering. In the final analysis, it was convenient to make the case at the level of macroeconomic aggregates. It was particularly easy to demand that a Republican president change his course. It was far less comfortable to question the house price boom and the giant Wall Street edifice erected on top of it.

Rigged Money: Beating Wall Street at Its Own Game by Lee Munson

affirmative action, Alan Greenspan, asset allocation, backtesting, barriers to entry, Bear Stearns, Bernie Madoff, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, call centre, Credit Default Swap, diversification, diversified portfolio, estate planning, fear index, fiat currency, financial engineering, financial innovation, fixed income, Flash crash, follow your passion, German hyperinflation, Glass-Steagall Act, global macro, High speed trading, housing crisis, index fund, joint-stock company, junk bonds, managed futures, Market Wizards by Jack D. Schwager, Michael Milken, military-industrial complex, money market fund, moral hazard, Myron Scholes, National best bid and offer, off-the-grid, passive investing, Ponzi scheme, power law, price discovery process, proprietary trading, random walk, Reminiscences of a Stock Operator, risk tolerance, risk-adjusted returns, risk/return, Savings and loan crisis, short squeeze, stocks for the long run, stocks for the long term, too big to fail, trade route, Vanguard fund, walking around money

All traders are concerned about is risk. Like gambling, traders look at what you have to put up and what you can get, or simple odds. Investment theories were always trying to compete for the expected return of the bet. This is when I started to listen more carefully to what Dr. Andrew Lo, a thought leader on hedge funds and financial engineering from the MIT Sloan School of Finance, was trying to get across. A peddler of ideas himself, he came up with Adaptive Market Hypothesis. I don’t know why it is a hypothesis—it’s simple. Survival is the game, and the game changes with each new crop of investors. Academia is not wrong, it is just too slow to adapt to the reality on the ground.

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In constructing modern, sophisticated, risk-budgeted portfolios, investors have a reasonable tool that Wall Street invented to circumvent an even more esoteric draconian structure from getting in the way. Is there a catch? Of course. The postscript to what is otherwise a feel-good tale of financial engineering for the good of portfolios is the seedy reminder that an edge costs money. Within a few years following the April 2009 inception of AMJ, a half dozen other MLP ETNs and a single ETF have come on the scene. Some weight the index differently, others just focus on gas, others focus on infrastructure over production, and some leverage the returns.

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Apparently, no one was watching despite the regulations on the brokerage and banking side. Just ask a bank trust officer and they will tell you about the hours of compliance work when you walk on both sides of the fence. Regulators were watching, but they didn’t have the tools to keep up with the financial engineering and technology that Greenspan thought would usher in a new era of prosperity. This Internet speed of change allowed a few players like AIG and Lehman Brothers to get away with poor risk management, greed, and ultimately a system that would fail. It took almost eight years for things to go wrong.

The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse by Mohamed A. El-Erian

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, Airbnb, Alan Greenspan, balance sheet recession, bank run, barriers to entry, Bear Stearns, behavioural economics, Black Monday: stock market crash in 1987, break the buck, Bretton Woods, British Empire, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, collapse of Lehman Brothers, corporate governance, currency peg, disruptive innovation, driverless car, Erik Brynjolfsson, eurozone crisis, fear index, financial engineering, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, fixed income, Flash crash, forward guidance, friendly fire, full employment, future of work, geopolitical risk, Hyman Minsky, If something cannot go on forever, it will stop - Herbert Stein's Law, income inequality, inflation targeting, Jeff Bezos, Kenneth Rogoff, Khan Academy, liquidity trap, low interest rates, Martin Wolf, megacity, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, Norman Mailer, oil shale / tar sands, price stability, principal–agent problem, quantitative easing, risk tolerance, risk-adjusted returns, risk/return, Second Machine Age, secular stagnation, sharing economy, Sheryl Sandberg, sovereign wealth fund, The Great Moderation, The Wisdom of Crowds, too big to fail, University of East Anglia, yield curve, zero-sum game

Internally, they had started to play a game of catch-up with dangerous circumstances that gradually became increasingly obvious over the next year, culminating in cascading failures that very few policymakers and market participants will ever forget. The second big visible tremor hit in March 2008. Bear Stearns, once one of America’s most established and reputable investment banks, found itself on the verge of a total collapse. Once again, complex financial engineering and extremely leveraged positioning were at the heart of the problem, together with inadequate understanding, sloppy supervision, and lax accounting given the extreme risk taking that all this entailed. And once again, dramatic central bank action—this time quarterbacked by the Federal Reserve under Chairman Bernanke—was needed to restore calm before things got really out of hand.

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GDP levels in the United States, United Kingdom, Japan, and EU This generally disappointing outcome speaks to an unfortunate reality: Too many advanced economies lack proper growth engines—though it’s not surprising, since they had gotten deeply hooked on an unsustainable approach that substituted financial engineering and credit entitlement for proper drivers of growth. To make things worse, rather than spur efforts to do better, the persistent recent underperformance has made it harder to secure the consensus needed to revamp growth engines in a fundamental and durable fashion. As I argued in 2013, quite a long list of countries emerged from the crisis saddled with the legacy of ill-designed, inadequate, and sputtering growth engines: “Some countries (for example, Greece and Portugal) relied on debt-financed government spending to fuel economic activity.

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While time will continue to heal many (but not all) balance sheets, this is unlikely to prove sufficient to produce high growth let alone enhance potential, and while cyclical rebounds will please many, they will prove frustratingly insufficient if they do not hand off to longer-term inclusive growth momentum (a point that the Economic Report of the President, prepared by the White House Council of Economic Advisers, led by Jason Furman, made in February 2015).2 With that, here are four key outputs of a reduced-form approach to the ten major challenges facing the global economy. 1. GETTING SERIOUS ABOUT INCLUSIVE ECONOMIC GROWTH The first component of a comprehensive solution involves rejecting financial engineering as a growth strategy and instead returning to the basic building blocks of economic prosperity. It entails a decisive exit from a global monetary configuration, public and private, that has depended for more than a decade now on injection after injection of artificial liquidity to mask the real, structural impediments to growth.

The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis by Tim Lee, Jamie Lee, Kevin Coldiron

active measures, Alan Greenspan, Asian financial crisis, asset-backed security, backtesting, bank run, Bear Stearns, Bernie Madoff, Bretton Woods, business cycle, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, currency risk, debt deflation, disinformation, distributed ledger, diversification, financial engineering, financial intermediation, Flash crash, global reserve currency, implied volatility, income inequality, inflation targeting, junk bonds, labor-force participation, Long Term Capital Management, low interest rates, Lyft, margin call, market bubble, Money creation, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, negative equity, Network effects, Ponzi scheme, proprietary trading, public intellectual, purchasing power parity, quantitative easing, random walk, rent-seeking, reserve currency, rising living standards, risk free rate, risk/return, sharing economy, short selling, short squeeze, sovereign wealth fund, stock buybacks, tail risk, TikTok, Uber and Lyft, uber lyft, yield curve

Carry trades can include everything from undertaking classic currency carry positions, writing insurance or selling credit default swaps, buying higher-yielding equities or junk debt on margin, taking out buy-to-rent mortgages to finance property investments, to writing put options on equities or equity indexes or buying exchange-traded funds that do so—but that is not all. Carry trades can also include dealings such as companies issuing debt to buy back their own equity or private equity leveraged buyouts, plus a whole gamut of more complex financial strategies and financial engineering. In all cases the carry trader is either explicitly or implicitly betting that changes in underlying capital values will not wipe out his or her income return; the carry trader is betting that underlying asset price volatility will be low or will decline. The final feature of carry trades is their sawtooth return pattern.

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But with the Federal Reserve cutting interest rates to close to zero and longer-term rates ratcheting down as global trend economic growth decayed further, other sectors of the US economy (and global economy) ramped up leverage in carry-type activities. Foremost in this development was the corporate sector. It was well known that corporates increased debt to finance share buybacks, thus raising earnings per share (see Chapter 5, Figure 5.2). But much less well understood is that it must have been also true that corporates were using financial engineering in ways that increased aggregate earnings; basically generating profits from carry trade activities. Circumstantial evidence for this is the behavior of profit share in GDP for the United States (Figure 8.3). Profit share developed in a rather similar pattern to the S&P 500 itself, which, as was explained in Chapter 6, became a giant carry trade.

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He also specializes in quantitative modeling of financial markets. He previously worked as a macro analyst for asset management companies GMO in Boston and Ruffer Asset Management in London. Jamie holds BA degrees in mathematics and in English from Dartmouth College, New Hampshire. Kevin Coldiron is a lecturer in the Masters in Financial Engineering Program at the Haas School of Business, University of California, Berkeley. From 2002 to 2014 he was the co-chief investment officer at San Francisco– based hedge fund Algert Coldiron Investors, which he cofounded. Prior to this he was managing director at Barclays Global Investors in London where he worked for eight years.

Value of Everything: An Antidote to Chaos The by Mariana Mazzucato

"Friedman doctrine" OR "shareholder theory", activist fund / activist shareholder / activist investor, Affordable Care Act / Obamacare, Airbnb, Alan Greenspan, bank run, banks create money, Basel III, behavioural economics, Berlin Wall, Big bang: deregulation of the City of London, bonus culture, Bretton Woods, business cycle, butterfly effect, buy and hold, Buy land – they’re not making it any more, capital controls, Capital in the Twenty-First Century by Thomas Piketty, carbon tax, Carmen Reinhart, carried interest, clean tech, Corn Laws, corporate governance, corporate social responsibility, creative destruction, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, European colonialism, Evgeny Morozov, fear of failure, financial deregulation, financial engineering, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, full employment, G4S, George Akerlof, Glass-Steagall Act, Google Hangouts, Growth in a Time of Debt, high net worth, Hyman Minsky, income inequality, independent contractor, index fund, informal economy, interest rate derivative, Internet of things, invisible hand, John Bogle, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, knowledge economy, labour market flexibility, laissez-faire capitalism, light touch regulation, liquidity trap, London Interbank Offered Rate, low interest rates, margin call, Mark Zuckerberg, market bubble, means of production, military-industrial complex, Minsky moment, Money creation, money market fund, negative equity, Network effects, new economy, Northern Rock, obamacare, offshore financial centre, Pareto efficiency, patent troll, Paul Samuelson, peer-to-peer lending, Peter Thiel, Post-Keynesian economics, profit maximization, proprietary trading, quantitative easing, quantitative trading / quantitative finance, QWERTY keyboard, rent control, rent-seeking, Robert Solow, Sand Hill Road, shareholder value, sharing economy, short selling, Silicon Valley, Simon Kuznets, smart meter, Social Responsibility of Business Is to Increase Its Profits, software patent, Solyndra, stem cell, Steve Jobs, The Great Moderation, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, Tobin tax, too big to fail, trade route, transaction costs, two and twenty, two-sided market, very high income, Vilfredo Pareto, wealth creators, Works Progress Administration, you are the product, zero-sum game

A new breed of financial operator has moved into the market, largely following a PE model, often ‘selling' many of its places to local authorities but also generating private profit. In 2015, the five biggest care home chains controlled about a fifth of the total number of care home beds in the UK. These operators were attracted by stable cash flows, part of which came from local authorities, and opportunities for financial engineering: cheap debt; property which could be sold and leased back; tax breaks on debt interest payments and carried interest; and - ultimately - frail and vulnerable residents whom the state would have to look after if the business failed. The corporate structures of some care home owners became exceedingly complex and often hidden in tax havens, while corporation tax payments were low or nil.

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Interestingly, the company with the lowest gearing (ratio of debt to equity) and the highest credit rating was Welsh Water, which is mutually owned. The four companies with the highest gearing and the lowest credit ratings were all PE-owned. Just like some of the care home groups, WSC ownership structures are often opaque. The combination of shadowy corporate structures and complex financial engineering may well explain high payouts to water company owners. Between 2009 and 2013 Anglian, Thames, United Utilities, Wessex and Yorkshire paid out more in dividends than they made in after-tax profits. Directors saw their share of the companies' income rise from 0.1318 per cent in 1993 to 0.2052 per cent in 2013.

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But the financialization of the industry was not anticipated in 1989, and neither price controls nor limits to returns on capital imposed on the companies by the Water Services Regulation Authority (Ofwat), the industry's economic regulator, appear to have prevented what looks like value extraction. The cases of care homes and water in Britain are not a blanket argument against PE or financialization. But they do illustrate how financial engineering of socially essential services can change the nature of an industry. It is at the very least debatable whether the opaque ownership and excessive financialization which characterize these PE-owned businesses serve their customers more than their owners. THE RETREAT OF ‘PATIENT' CAPITAL Agency theory and MSV, then, are essentially straightforward concepts.

The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds by Maneet Ahuja, Myron Scholes, Mohamed El-Erian

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, Alan Greenspan, Asian financial crisis, asset allocation, asset-backed security, backtesting, Bear Stearns, Bernie Madoff, book value, Bretton Woods, business process, call centre, Carl Icahn, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, en.wikipedia.org, family office, financial engineering, fixed income, global macro, high net worth, high-speed rail, impact investing, interest rate derivative, Isaac Newton, Jim Simons, junk bonds, Long Term Capital Management, managed futures, Marc Andreessen, Mark Zuckerberg, merger arbitrage, Michael Milken, Myron Scholes, NetJets, oil shock, pattern recognition, Pershing Square Capital Management, Ponzi scheme, proprietary trading, quantitative easing, quantitative trading / quantitative finance, Renaissance Technologies, risk-adjusted returns, risk/return, rolodex, Savings and loan crisis, short selling, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, stock buybacks, systematic bias, systematic trading, tail risk, two and twenty, zero-sum game

he exclaimed, half-jokingly as we sat in his glass office surrounded by forest and a lake in Westport, Connecticut. “What we’re called and how we’re categorized, by our basic structure, doesn’t capture the essence of what we are,” he quipped. “I trade long and short,” he continued. “Does that make me a hedge fund?” he asks rhetorically. “No. I consider myself a financial engineer. I started trading commodities. Then commodities became various futures, which evolved into various swaps and derivatives. I could separate things in a way that was unique. I evolved.” These elements are not exactly encompassed by the definition of a hedge fund, which, at its core, groups many of the world’s most sophisticated investors by nothing more than a compensation structure.

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In January 2008, Dalio forewarned of the dangers of overreliance on tools like historical models during an interview with the Financial Times. “What is the most common mistake of investors?” he warned. “It is believing that things that worked in the past will continue to work and leveraging up to be on it. Nowadays, with the computer, it is easy to identify what would have worked and, with financial engineering, to create overoptimized strategies. I believe we are entering a period that will not be consistent with the back-testing, and problems will arise. When that dynamic exists and there’s close to zero interest rate, we knew that the ability of the central bank to ease monetary policy is limited.”

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Pershing’s TIP REIT was initially well received by Target’s senior management and its adviser Goldman Sachs. In September 2008, Target’s board considered the potential REIT transaction. Unfortunately for Pershing, the Target board met shortly after Fannie, Freddie, AIG, and Lehman failed, and the board did not have any appetite for what looked like a financial engineering transaction. Rejected by the company, Ackman decided to go public with his TIP REIT proposal in a town hall format. Shortly after its November 2008 presentation, Target summarily rejected Pershing’s proposal, citing a number of concerns. A few weeks later Ackman made a second public presentation attempting to address Target reservations about the plan, but which Target again rejected.

Nine Crises: Fifty Years of Covering the British Economy From Devaluation to Brexit by William Keegan

Alan Greenspan, banking crisis, Bear Stearns, Berlin Wall, Big bang: deregulation of the City of London, Boris Johnson, Bretton Woods, Brexit referendum, British Empire, capital controls, congestion charging, deindustrialization, Donald Trump, Etonian, eurozone crisis, Fall of the Berlin Wall, financial engineering, financial innovation, financial thriller, floating exchange rates, foreign exchange controls, full employment, gig economy, inflation targeting, Jeremy Corbyn, Just-in-time delivery, light touch regulation, liquidity trap, low interest rates, Martin Wolf, military-industrial complex, moral hazard, negative equity, Neil Kinnock, Nixon triggered the end of the Bretton Woods system, non-tariff barriers, North Sea oil, Northern Rock, oil shock, Parkinson's law, Paul Samuelson, pre–internet, price mechanism, quantitative easing, Ronald Reagan, school vouchers, short selling, South Sea Bubble, Suez crisis 1956, The Chicago School, transaction costs, tulip mania, Winter of Discontent, Yom Kippur War

However, Brown freely acknowledged in retrospect that it had been a mistake to subscribe to what had become an international consensus. This consensus, led by the then chairman of the Federal Reserve, Alan Greenspan, held that the sophistication of modern financial markets had reduced the dangers of a financial crisis via the diversification of risk, all those fancy new ‘products’ and what became known as ‘financial engineering’. During the summer of 2007, and the advent of the Northern Rock crisis, Brown had moved on to No. 10, and his long-time colleague and fellow Scot Alistair Darling was installed at the Treasury. Governor King may not have been over-interested in regulation, but Darling certainly was. Indeed, in his instant memoir of the crisis, Darling disarmingly admits that, as shadow minister for the City in the run-up to the 1997 election, he had been largely responsible for the architecture of the FSA.

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I myself first became aware of the international repercussions when on holiday at our annual retreat in Puyméras, the heart of Côtes du Rhône country, near Gigondas and Chateauneuf du Pape. On 9 August, the French bank BNP Paribas froze three of its investment funds. As the crisis unfolded, it became evident that globalised financial engineering had certainly spread risk. But there were also the risks of ‘irrational exuberance’. Way back in the late ’90s, the then Governor of the US Federal Reserve, Alan Greenspan, had expressed concern about ‘irrational exuberance’ in the markets. But they had seen nothing yet. The spreading of risk had ensured that European financial institutions, not least supposedly staid German banks, were also severely affected by what had begun as the US sub-prime crisis.

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After I had duly introduced myself, he said, ‘We didn’t have a banking crisis in Canada.’ Canada’s experience was the exception to the rule that, in a globalised financial world, with sub-prime ‘paper’ turning up on bank balance sheets all over Europe, it was difficult to avoid being tainted by the crisis. For a time, it was fashionable to blame financial engineering for the banking crisis but in Thucydidean terms the truest cause could well have been a recrudescence of the historical pattern of greed and excessive risk-taking – parallels with the Dutch tulip mania and South Sea Bubble – to relieve so many people of their senses. But the assumed sophistication of the global financial system was the proximate cause and was to magnify the effects.

What They Do With Your Money: How the Financial System Fails Us, and How to Fix It by Stephen Davis, Jon Lukomnik, David Pitt-Watson

activist fund / activist shareholder / activist investor, Admiral Zheng, banking crisis, Basel III, Bear Stearns, behavioural economics, Bernie Madoff, Black Swan, buy and hold, Carl Icahn, centralized clearinghouse, clean water, compensation consultant, computerized trading, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crowdsourcing, David Brooks, Dissolution of the Soviet Union, diversification, diversified portfolio, en.wikipedia.org, financial engineering, financial innovation, financial intermediation, fixed income, Flash crash, Glass-Steagall Act, income inequality, index fund, information asymmetry, invisible hand, John Bogle, Kenneth Arrow, Kickstarter, light touch regulation, London Whale, Long Term Capital Management, moral hazard, Myron Scholes, Northern Rock, passive investing, Paul Volcker talking about ATMs, payment for order flow, performance metric, Ponzi scheme, post-work, principal–agent problem, rent-seeking, Ronald Coase, seminal paper, shareholder value, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, Steve Jobs, the market place, The Wealth of Nations by Adam Smith, transaction costs, Upton Sinclair, value at risk, WikiLeaks

One might have thought that the banks’ “owners,” meaning the institutional investors who use our money to hold the banks’ stock, would have discouraged such behavior for fear of being burnt. In fact, their virtual fingerprints were all over the banks that undertook excessive risks. According to a forensic report by economist John Kay, Wall Street–style investors encouraged “companies to engage in financial engineering, to run their businesses ‘to make the numbers,’ or otherwise to emphasize short term financial goals at the expense of the development of the business capabilities.”18 “Short-termism is a disease that infects American business and distorts management and boardroom judgment,” asserted Martin Lipton, Theodore Mirvis, and Jay Lorsch in a 2009 paper.

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Your bank likely will sell your mortgage to an underwriter, who will combine your mortgage with others into a pool of mortgages that can then be traded, which then adds a plethora of other agents such as traders, mortgage desks at investment banks, risk management professionals, derivative salespeople, and financial engineers. Every agent along the way gets paid and, to be sure, deserves to get paid, just as they do in any other industry that has a complex supply chain. Each step along the way makes perfect sense, but there are a lot of steps. Seemingly simple transactions become very complicated when you actually look at the mechanics of finance, and at each step there are numerous opportunities for agents to extract fees, often without our being aware of it.

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DE-EMPHASIZE TRADING AND SPECULATION, AND REWARD INVESTING FOR THE LONG TERM Market conditions encourage trading in public stocks based on price, rather than investing in public companies based on value. Here are suggestions for how to reverse that trend. Tim MacDonald of the Capital Institute has proposed a different form of ownership for long-term investors. In a back-to-the-future synthesis of modern financial engineering and old-fashioned direct ownership, he would have pension funds, endowments, insurance companies, sovereign wealth funds, and other large long-term investors curtail their public market investments, getting away from what he calls the tyranny of the trading tape. MacDonald’s idea, which he calls “evergreen direct investing,” is that an investor would make a direct investment into a company.

Automate This: How Algorithms Came to Rule Our World by Christopher Steiner

23andMe, Ada Lovelace, airport security, Al Roth, algorithmic trading, Apollo 13, backtesting, Bear Stearns, big-box store, Black Monday: stock market crash in 1987, Black-Scholes formula, call centre, Charles Babbage, cloud computing, collateralized debt obligation, commoditize, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, Donald Trump, Douglas Hofstadter, dumpster diving, financial engineering, Flash crash, G4S, Gödel, Escher, Bach, Hacker News, High speed trading, Howard Rheingold, index fund, Isaac Newton, Jim Simons, John Markoff, John Maynard Keynes: technological unemployment, knowledge economy, late fees, machine translation, Marc Andreessen, Mark Zuckerberg, market bubble, Max Levchin, medical residency, money market fund, Myron Scholes, Narrative Science, PageRank, pattern recognition, Paul Graham, Pierre-Simon Laplace, prediction markets, proprietary trading, quantitative hedge fund, Renaissance Technologies, ride hailing / ride sharing, risk tolerance, Robert Mercer, Sergey Aleynikov, side project, Silicon Valley, Skype, speech recognition, Spread Networks laid a new fibre optics cable between New York and Chicago, transaction costs, upwardly mobile, Watson beat the top human players on Jeopardy!, Y Combinator