The Trade Lifecycle

CHAPTER 1

Trading 3

1.1 How and why do people trade? 3

1.2 Factors affecting trade 3

1.3 Market participants 4

1.4 Means by which trades are transacted 5

1.5 When is a trade live? 7

1.6 Consequences of trading 7

1.7 Trading in the financial services industry 8

1.8 What do we mean by a trade? 10

1.9 Who works on the trade and when? 11

1.10 Summary 12

CHAPTER 2

Risk 13

2.1 The concept of risk 13

2.2 Risk is inevitable 13

2.3 Quantifying risk 14

2.4 Methods of dealing with risk 15

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2.5 Managing risk 15

2.6 Problems of unforeseen risk 16

2.7 Summary 16

CHAPTER 3

Understanding Traded Products – Follow the Money 17

3.1 Spot trades 18

3.2 Future (forward) 20

3.3 Loan 21

3.4 Deposit 23

3.5 Swap 23

3.6 Foreign exchange swap 25

3.7 Equity spot 26

3.8 Bond spot 27

3.9 Option 27

3.10 Credit default swap 30

3.11 Summary 31

CHAPTER 4

Asset Classes 33

4.1 Interest rates 33

4.2 Foreign exchange (Forex or FX) 40

4.3 Equity 44

4.4 Bonds and credit 46

4.5 Commodities 53

4.6 Trading across asset classes 58

4.7 Summary 59

CHAPTER 5

Derivatives, Structures and Hybrids 61

5.1 Linear 61

5.2 Nonlinear 62

5.3 Some option terminology 66

5.4 Option valuation 67

5.5 Exotic options 67

5.6 Structures and hybrids 69

5.7 Importance of simpler products 70

5.8 Trade matrix 71

5.9 Summary 72

CHAPTER 6

Liquidity, Price and Leverage 73

6.1 Liquidity 73

6.2 Price 75

PART TWO

The Trade Lifecycle

CHAPTER 7

Anatomy of a Trade 83

7.1 The underlying 83

7.2 General 83

7.3 Economic 84

7.4 Sales 84

7.5 Legal 84

7.6 Booking 85

7.7 Counterparty 85

7.8 Timeline 86

7.9 Summary 87

CHAPTER 8

Trade Lifecycle 89

8.1 Pre execution 89

8.2 Execution and booking 91

8.3 Confirmation 94

8.4 Post booking 96

8.5 Settlement 97

8.6 What happens overnight 101

8.7 Changes during lifetime 105

8.8 Reporting during lifetime 110

8.9 Exercise 110

8.10 Maturity 112

8.11 Example trade 113

8.12 Summary 115

CHAPTER 9

Cashflows and Asset Holdings 117

9.1 Holdings 119

9.2 Value of holding 120

9.3 Reconciliation 121

9.4 Consolidated reporting 122

9.5 Realised and unrealised P&L 122

9.6 Diversification 122

9.7 Bank within a bank 123

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9.8 Custody of securities 123

9.9 Risks 124

9.10 Summary 124

CHAPTER 10

Risk Management 125

10.1 Traders 125

10.2 Risk control 126

10.3 Trading management 126

10.4 Senior management 126

10.5 How do risks arise? 126

10.6 Different reasons for trades 128

10.7 Hedging 128

10.8 What happens when the trader is not around? 128

10.9 Types of risk 130

10.10 Trading strategies 132

10.11 Hedging strategies 133

10.12 Summary 134

CHAPTER 11

Market Risk Control 135

11.1 Various methodologies 135

11.2 Need for risk 139

11.3 Allocation of risk 139

11.4 Monitoring of market risk 140

11.5 Controlling the risk 140

11.6 Responsibilities of the market risk control department 141

11.7 Limitations of market risk departments 142

11.8 Regulatory requirements 143

11.9 Summary 145

CHAPTER 12

Counterparty Risk Control 147

12.1 Reasons for non-fulfilment of obligations 147

12.2 Consequences of counterparty default 148

12.3 Counterparty risk over time 148

12.4 How to measure the risk 149

12.5 Imposing limits 152

12.6 Who is the counterparty? 153

12.7 Collateral 153

12.8 Activities of the counterparty risk control department 154

12.9 What are the risks involved in analysing credit risk? 157