20 CHAPTER ◆ 2 Key Concepts and Definitions of Terms
include the valuation of derivatives instruments such as options, futures and swaps,
the trading of securities, risk management and regulation of financial markets.
No single set of mathematical tools, computational techniques or financial
theory describes financial engineering. Rather, it is the synthesis of a variety
of these elements. Financial engineering is a practical field and a practitioners ’
field by its nature. It is driven in large part by practical problems that arise in the
course of daily business; the nature of the problems demand that practitioners
draw from as broad a palate of tools as possible to find the best solutions to their
problems.^11Financial engineers on the trading side come in two flavors: multifactor quants and
arbitrage quants. Multifactor quants use multifactor models to develop funds that can
quickly switch between sectors and investment styles to take advantage of changing mar-
ket trends. Arbitrage quants use derivatives, short-selling, and leverage to take advantage
of small, short-term inefficiencies in markets. Multifactor quants develop multifactor and
filter systems, whereas arbitrage quants develop filter and trigger systems.2.12. Gate
Our methodology borrows gates from Dr. Robert G. Cooper ’ s Stage-Gate® method.^12
Gates are meetings where go/kill decisions are made, where weak projects are weeded
out, and scarce resources are reallocated toward more promising projects. Gates act as
checkpoints along the new product development process. Where traditional gates allow
only for two outcomes—either a go or kill decision—K| V allows for five potential out-
comes: go, kill, hold, return, trade.2.13. Innovation
Innovations are essentially new ideas, in the form of new products, methods, or even sim-
ply new improvements to old ideas. More concrete are our definitions of bottom-up and
top-down innovation.● Bottom-up innovation is research-driven innovation, where product teams invent
new strategies with breakthrough research. Systems built in this way may then be
offered to customers. This is essentially a quality engineered solution in search of a
market need.
● Top-down innovation is driven by explicit customer needs, where investor research
uncovers demand for certain types of risk. A product team then focuses on develop-
ing a trading/investment system to satisfy that demand. This is the more traditional
customer need in search of a quality solution.Management should cultivate several forms of both of these types of innovation.
Whatever the driver of innovation, in either case, both customer quality, that is, investor
satisfaction, and engineered quality must be achieved.