Principles of Financial Engineering (Academic Press Advanced Finance) Hardcover – 9 Dec 2008
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"Its focus on financial engineering and the actual use of derivative instruments makes Neftci's book an extremely useful complement to the standard introductions to derivative pricing and financial mathematics. The value of the text has been enhanced further by the addition of five chapters on structured products and credit derivatives not present in the first edition."
--Rüdiger Frey, University of Leipzig
“Since its publication in 2004, Neftci's book has become the de facto reference text for financial engineering practitioners and academics. With renewed and extended emphasis on structured products engineering, Neftci keeps the material relevant and up to date for the current state of the financial markets.
--Dan Stefanica, Baruch College
About the Author
Professor Neftci completed his Ph.D. at the University of Minnesota and was head of the FAME Certificate program in Switzerland. He taught at the Graduate School, City University of New York; ICMA Centre, University of Reading; and at the University of Lausanne. He was also a Visiting Professor in the Finance Department at Hong Kong University of Science and Technology. Known his books and articles, he was a regular columnist for CBN daily, the most influential financial newspaper in China.
Top customer reviews
A good ground up book. dont bother buying it unless you are keen though as some of this can be hard going untill you get into the swing.
Most helpful customer reviews on Amazon.com
clear text and illustrate the product in graph. reader could understand the buliding block of the financial
product. This is a great textbook in financial engineering.
As is often the case with textbooks, they skimp on examples, solutions and problems. I also found the graphics to be sub-par, though admittedly adequate.
It appears that the book was published in a hurry. It contains many typos, for example, on page 5 -figure 1.4(a) (Note the there will .....). Can not believe these types of errors were not caught in the review by AP publisher.
The book was given some high ratings from some readers on Amazon. I do not believe these ratings are compatible to the ones given to similar books such as the book "Introduction to future and options" by John Hull.
The book's essence is to illustrate the financial engineer's modus operandi: the deconstruction of a complex instrument into its synthetic equivalent, a replicating portfolio of simpler building block instruments, that mimics the instrument's economics (cash flows and risk). By the end, you will see financial instruments as combinations of basic positions.
His favor to the reader is heavy use of cash flow diagrams. Initially, I thought these would be tedious; but I soon become convinced these are extremely useful frameworks.
For example, take a credit default swap (CDS). Neftci "solves" for the CDS cash flows sequence by combining the cash flows (literally combining cash flow diagrams) of three other instruments, so we can see exactly how a bond is synthetically replicated:
* Long risky bond = Short CDS (sell protection) + make default-free LIBOR-based money market deposit + receive-fixed in an interest rate swap, or
* Short CDS = Long a risky bond + borrow at money market rate + pay-fixed in an interest rate swap
So, the "replicated" short CDS position (selling protection) works as follows. Funds to purchase the risky bond are borrowed at LIBOR floating; coupons are received from the bond. Most of the risky bond coupon goes to pay the fixed-rate on the interest rate swap. The received LIBOR coupon on the swap exactly funds the interest rate on the borrowed funds. Which leaves the remainder of the risky bond coupon; i.e., the swap spread. And, under this simple model, the credit spread over the swap rate should equal the CDS premium.
My favorite parts of the book:
Chapter 2 is useful review of market conventions; e.g., different yields
Chapter 4 put swaps at the center of financial engineering: he shows how swaps are a "the equivalent of zero in finance" and how a swap can be deconstructed from virtually any cash instrument.
His approach perfectly lends itself to viewing options as volatility instruments (Chapter 8). Not new per se, but it finds an intuitive explanation under his method: a delta-neutral portfolio consists of a long (funded) call plus a short position in the underlying stock (of delta units), such that any volatility produces a profit. The long call is long volatility.
Chapter 10 reviews exotic options, but as you'd expect, exotics are brilliantly displayed with their synthetic equivalents; e.g., a binary call is replicated by a long call plus a short call with higher strike price.
Theory on risk neutral probabilities with applications
Entire chapter on volatility positions (i.e., portfolios that isolate on volatility as the risk factor)
Additional material (from the first edition) on credit markets, CDS, structured products, credit indices and correlation pricing
Finally, the other rare achievement of this book is that it adresses several levels of proficiency. There is something for everbody, from the beginner to the advanced engineer. Few finance books actually pull this off.
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