Carlos Gamez Math Finance Honor Society University of Utah. Financial Engineering. What is Financial Engineering?. Financial Engineering refers to the bundling and unbundling of securities . This is done in order to maximize profits using different combinations of
Math Finance Honor Society
University of Utah
This is done in order to maximize
profits using different combinations of
equity, futures, options, fixed income,
Generally, Financial Engineers are strong on the following fields:
For the Issuer
For the Holder
Traditionally, securities are divided into debt securities and equity.
Debt securities may be called debentures, bonds, notes or commercial paper depending on their maturity and certain other characteristics.
The holder of a debt security is typically entitled to the payment of principal and interest, together with other contractual rights under the terms of the issue, such as the right to receive certain information.
Debt securities are generally issued for a fixed term and redeemable by the issuer at the end of that term.
The Weighted Average Cost of Capital (WACC) is used in finance to measure a firm's cost of capital.
The cost of capital is then given as:
Kc = (1-δ) Ke + δ Kd
Kc The weighted cost of capital for the firm
δ The debt to capital ratio, D / (D + E)
Ke The cost of equity
Kd The after tax cost of debt
D The market value of the firm's debt, including bank loans and leases
E The market value of all equity (including warrants, options, and the equity portion of convertible securities)
WACC = (1 - debt to capital ratio) * cost of equity + debt to capital ratio * cost of debt
The basic theorem states that, in the absence of taxes, bankruptcy costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed. It does not matter if the firm's capital is raised by issuing stock or selling debt. It does not matter what the firm's dividend policy is. Therefore, the Modigliani-Miller theorem is also often called the capital structure irrelevance principle.
y = C0 + D/E (C0 – b)
* y is the required rate of return on equity, or cost of equity.
* C0 is the cost of capital for an all equity firm.
* b is the required rate of return on borrowings, or cost of debt.
* D / E is the debt-to-equity ratio.