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Mathematics in the Financial Markets
For many financial analysts, it is important to grasp the meaning of mathematics in economics since every sub-category of maths is a part of financial calculations. Many people fail to recognize the importance of mathematics as a tool for making estimates in the financial market. Moreover, people are not even aware of the businesses in financial markets are and what kind of work it includes. Mathematical traps are all over the place and for more accurate predictions they need to be identified properly.
The financial market is referred to buying and selling assets and the trading risk which comes with the undertaking. The thing is we are not referring to familiar banks which are more or lessr retailers, like the famous Barclays or Royal Ban, etc., as well as not to mergers and acquisitions. The bigger names behind these retail enterprises are usually in the background and unknown to common people like Deutsche Bank, Goldman Sachs, and others.
A business in the financial market can be compared to any other industrial company where there are different kinds of jobs, levels, products, quality control and other factors that influence the business and eventually the success of the enterprise.
In the financial market, financiers have to deal with tradable asset classes and the different jobs of employees.
What are Asset Classes?
The risk is the word that is highly associated with the financial market which is further associated with banks. Banks are also exposed to risk since they could lose or gain money depending on how the asset moves in the market; is it dropping in value or rising?
There are five classes of assets which are based on the risk-factor the banks have to take in the financial market. They are:
- Interest rates represent the rate at which the money is borrowed and lent. It refers to all borrowers/lenders, e.g. individuals, corporate companies, banks, and governments. The rates are usually defined somewhere around 0.01% and extend from overnight to 30 or more years.
- Foreign Exchange or abbreviated Forex include rates of currencies. Investors buy one currency at one rate to buy another one at the same or a different rate. The rates define the net value, and the goal is to sell at a higher price but buy at a lower price to increase one’s assets.
- Equities represent shares and stocks one owns, and they work on similar principles as the FOREX Exchange Market.
- Credit is also linked to the likelihood of being paid back. Interest rates will not be the same for all since higher rates will be applied to those who are more likely not to repay what they own and higher interest serves as a safety net. When someone is more likely to pay their loan, then the interest rate is generally lower.
- Commodities include oil, silver, gold, gas, and other commodities which can be traded in the market.
The banks usually do not enter a trade without reason, and the most common reasons include the following:
- Hedging is the approach a bank will use when the interest rates move in the market; a s well as currency values which increase the trading risk. In such a situation, the bank will usually carry out a trade to return to the formerly acceptable level of risk.
- New business will encourage the bank to help a corporate client in risk management in order to minimize the risk.
- Proprietary trading is when a bank makes predictions on how interest rates will move and enter a trade with expectations to gain profit, but they also enter a risk of loss if things turn out differently. Even if it is called proprietary trading, it is equal to gambling, taking a blind shot at what is might going to happen.
If we consider the second reason, the new business example is crucial in terms that the bank offers its services to an individual or company that is not bank-related. How it works can be seen in the following examples.
Let’s assume that a corporate company can borrow money in GBP at a cheaper rate than the CHF, but yet, the company needs the Swiss Franc. In order to keep the funding cheap in the desired currency CHF, the company can first borrow in GDP at a cheaper rate. Getting the money in cash (but subject to the interest rate) it negotiates a swap with the bank. Swap is an interest rate asset here. Thereby, the bank agrees to pay the GBP interest rate instead of the company and to give the company CHF in exchange for GBP, with the requirement that the company pays interest on CHF to the bank.
The Different Jobs in Financial Markets
There are four major roles or jobs which characterize the financial market, and they are trading, sales structuring, and derivative research (or quants). The trade people are the ones who convince banks to take action in the financial market, and they are the responsible ones from the beginning to an end of a trade and transaction. Traders also minimize the net risks by carrying out additional business decisions. They are supposed to possess great mathematical skills in order to make accurate predictions and to understand the price movements thoroughly. Sales personnel do pretty much the usual, talking to clients, entering collaborations with them, discuss their needs, etc. These employees do not need to possess thorough knowledge on the different assets, but yet they have to be familiar to some extent, and their main asset is strong communication skills.
Structuring is a narrower field since it represents particular fields. Their main tasks are related to figuring out solutions to clients’ problems. They are also familiar with accounting, pricing transactions, and with the management of traders.
Derivative researchers are called in when dealing with complex transactions which take on an advisory role in recommending what model what be suitable in a situation. Sometimes, they even develop new models which could be applied to the new situation.