Time to embrace financial engineering

The importance of financial engineering comes not only from its specific features, but is also underpinned by areas of the economy where it has been applied so far and where it is going.
From the minds of many, engineering refers to the application of scientific principles, especially those related to the properties of matter, to create physical products useful to the human race.
However, with this information age we have come up with variations like “software engineering” to bestow scientific grandeur to the practice of writing software. Leading educational institutions like Oxford, University of Reading, Columbia, MIT, etc, have been offering programmes leading to degrees in “financial engineering”.
Pretoria University of South Africa, Multimedia University of Malaysia, Jomo Kenyatta University of Kenya and locally Harare Institute of Technology (HIT) have all embraced the idea by introducing their home-grown versions to tackle their local financial markets.
What is Financial Engineering?
While much has been said about financial innovation, one major element of that innovation is that involving financial instruments.
According to Marshall (1992), the process of adaptating existing financial instruments and processes to develop new ones, in order for financial market participants to effectively cope with the changing situation, is known as financial engineering.
Financial engineering has become an independent discipline with its own professional bodies with the International Association of Financial Engineers (IAFE) as the global body. The primary objective of financial engineering is to meet the needs of risk management.
FE takes a building block approach to the building of new instruments. Black and Scholes (1973) first demonstrated this approach in considering a call option as a continuously adjusting portfolio of two securities.
Most of the objectives of financial engineering can be better met by use of futures, forwards, options and swaps, which are now known as the building blocks of financial engineering.
By combining forwards, options, futures and swaps, with the underlying cash position, a firm’s risk exposure can be manipulated in practically infinite ways.
Why Financial Engineering?
Current trends of economic and political nature such as deficits and budget consolidations indicate that now and in the future measures that increase the leveraging of public spending will be particularly useful.
Just recently, announcing the mid-term fiscal policy review, Finance Minister Tendai Biti slashed the 2012 National Budget by 10 percent. As the increased role of public sector and public funding might stay with us for a while, financial engineering can contribute to improving its quality and efficiency.
Some of the most critical needs of our economy need to have financial instruments better tailored to support entrepreneurship and infrastructure development, including that to do with energy creation puts financial engineering on the forefront.
Generally, financial engineering can help solve some of society’s biggest problems and in the process allow for the modernisation and development of financial markets.
It also works as a catalyst for partnership and co-operation as they can be tailored to specific needs of partners of a sector.
This can be a critical tool for some of our ailing parastatals as there is high need to raise fresh capital and engage in strategic ventures.
With the current advances in technology and communication whereby it is now possible to transfer funds using cellphones and ATMs.
Globalisation of the world economy and increased competition from low-cost producing countries means we need to get our act together and innovate if our industry is to remain relevant, while financial engineering puts the knowledge icing to the innovations.
One writer advocates that, financial engineering = knowledge + imagination.
With Government debt soaring in developing countries there is high need for engineered strategies to free ourselves from this bondage as has been adopted by some South American countries with positive results.
In order to fully exploit the potential of financial instruments, we have to go beyond the approach of overcoming obstacles, to enhancing their potential and see opportunities in every sector of our economy, while being as innovative in designing financial instruments in the future.
However, more work is needed to better understand the impact on the ground and barriers to overcome.
For effective implementation, however, we may need a much bolder regulatory framework that would go beyond overcoming barriers towards truly facilitating and enhancing new financial instruments.
In summation, financial engineering as a major discipline within finance is playing an important role in the global financial market and has come to stay; therefore Zimbabwe should be as visionary and embrace it now. LET FINANCE BE ENGINEERED!

Thomas Muserepwa is a Financial Engineering student at the Harare Institute of Technology and president of the Financial Engineering Society (FES). He is currently attached at GMRI Capital.