Journal Detail

Journal 20 – Securities

September 2007

This issue of the journal attempts to provide an in depth assessment of how a number of the most famous new financial products are engineered and how financial institutions can best prepare themselves to settle and clear them.

The volume and complexity of securities manufactured and traded within the financial services industry has grown exponentially over the past three decades. Ever since the world of finance was introduced to complex valuation models, specifically the Options Pricing Model, financial engineers have been developing new ways to combine basic assets and create payoffs and risks that are highly complex and extremely fascinating. As our knowledge of these instruments has increased, so has our ability to create increasingly synthetic structures, which have made it possible to decompose risk elements and transfer them from one party to another; the result of which has been an overall reduction in the risks that the industry faces. However, sadly, this relationship has not always been direct. In recent years, the complexity of certain products has been so great that it has been close to impossible to determine the inherent risks that they possess and introduce into the marketplace. It is only through a better understanding of these instruments that we will be able to ascertain their true risks, and in the process attribute correct valuations to them.

These risks are not, however, limited to the determination of the financial obligations that institutions have with each other. As the complexity of these instruments has increased, so has the difficulty in decomposing them into their individual elements in order to be settled and cleared. Many operations and IT departments of financial institutions are under huge strain trying to process these transactions. As the complexity increases, so will the difficulty in processing them in an efficient and expedient manner.

It is this combination of financial and operational risks that has resulted in this issue of the Journal being dedicated to the topic of Securities. Part one focuses on some of the more interesting securities that have been developed in recent years and assesses how they help mitigate or increase the financial risks that the industry faces. Part two looks at the operational risks that these ever more complex products introduce into the financial system and provides some advice on how they can be reduced.