Financial Mathematics is the application of mathematical methods to the

solution of problems in finance. (Equivalent names sometimes used are

quantitative finance, financial engineering, mathematical finance, and
computational finance.) It draws on tools from probability, statistics,
stochastic processes, and economic theory. Traditionally, investment banks,
commercial banks, hedge funds, insurance companies, corporate treasuries,
and regulatory agencies apply the methods of financial mathematics to such
problems as derivative securities valuation, portfolio structuring, risk
management, and scenario simulation. Industries that rely on commodities
(e.g. energy, manufacturing) also use financial mathematics. Quantitative
analysis has brought efficiency and rigor to financial markets and to the
investment process and is becoming increasingly important in regulatory
concerns.
Quantitative Finance as a sub-field of economics concerns itself with the
valuation of assets and financial instruments as well as the allocation of
resources. Centuries of experience have produced fundamental theories
about the way economies function and the way we value assets. Models
describe relationships between fundamental variables such as asset prices,
market movements and interest rates. These mathematical tools allow us to
draw conclusions that can be otherwise difficult to find or not immediately
obvious from intuition. An example of the application of models is stresstesting of banks. Especially with the aid of modern computational
techniques, we can store vast quantities of data and model many variables
simultaneously, leading to the ability to model quite large and complicated
systems. Thus the techniques of scientific computing, such as numerical
analysis, Monte Carlo simulation and optimization are an important part of
financial mathematics.
A large part of any science is the ability to create testable hypotheses based
on a fundamental understanding of the objects of study and prove or
contradict the hypotheses through repeatable studies. In this light,
mathematics is the language for representing theories and provides tools for
testing their validity. For example, in the theory of option pricing due to
Black, Scholes and Merton, a model for the movement of stock prices is
presented, and in conjunction with theory which states that a riskless
investment will receive the risk-free rate of return, the researchers reasoned
that a value can be assigned to an option.
This theory, for which Scholes and Merton were awarded the Nobel prize, is
an excellent illustration of the interaction between math and financial theory,
which ultimately led to a surprising insight into the nature of option prices.

The mathematical contribution was the basic stochastic model (Geometric

Brownian motion) for stock price movements and the partial differential
equation and its solution providing the relationship between the options
value and other market variables. Their analysis also provided a completely
specified strategy for managing option investment which permits practical
testing of the models consequences. This theory, which would not have
been possible without the fundamental participation of mathematics, today
plays an essential role in a trillion dollar industry.