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Andrew Chen likes to think of himself as a "financial engineer." Chen, distinguished professor of finance in Cox School of Business, studies how businesses and governments can reduce their risk exposures and improve their bottom lines by making better use of financial resources. For example, Chen says, financial engineers have been able to help banks greatly reduce the cost of making transactions. "Previously a bank transaction using a teller cost an average of $1.27," Chen says. "If customers use an ATM machine, that transaction costs only 27 cents. If they use online banking, it is only one cent." As a result, Chen says, major commercial banks now offer their customers online banking services free of charge – providing better service to their customers and reducing their operating expenses at the same time. Corporations use financial engineering to reduce financing costs or hedge their exposure to currency price risks, Chen says. For example, in the past a corporation may have issued stock to raise money. Today, they could arrange a loan through a foreign bank and save hundreds of thousands of dollars as well as the time-consuming process of registering with the Securities and Exchange Commission (SEC), he says. Careful applications of financial engineering also can help governments raise funds at lower costs. For example, governments can issue inflation-indexed bonds to reduce their costs of borrowing by not paying inflation premiums, or can issue "puttable" bonds that guarantee a certain return, thus lowering the risk for investors. Financial engineering techniques also can be used to provide solutions to numerous problems that have plagued large-scale public infrastructure projects in emerging nations, Chen says. He suggests that financing of such projects should be privatized to eliminate the bribery, corruption, and inefficiency that often occur when politicians handle the financing. Financial engineers in all sectors use derivatives, which can provide high rates of return, but are also very risky if used incorrectly. Chen specializes in studying the growing market for derivatives – and some of the financial disasters that have resulted from their use. In 1994, for example, Orange County, California, lost $1.64 billion from some speculative high-leverage investment strategies. Chen’s analysis of recent derivative debacles indicates that most are caused by lack of knowledge about derivatives usage among senior managers and lack of internal control systems in many banks, corporations, and governments. "Collaboration among universities, corporations, and governments is essential to train well-qualified financial engineers," Chen says. "Good financial engineers should have a thorough understanding of advanced mathematical concepts, as well as the financial and computational tools required for the design and application of financial derivatives." Chen joined the SMU faculty in 1983 after teaching appointments at The Ohio State University, the University of California at Berkeley, and the State University of New York at Buffalo. He received his Bachelor’s degree in economics from the National Taiwan University and received a Master’s degree in economics and a Ph.D. in finance from the University of California at Berkeley. For more information: Andrew Chen
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