9780470685914

The Trade Lifecycle Behind the Scenes of the Trading Process

by
  • ISBN13:

    9780470685914

  • ISBN10:

    0470685913

  • Format: Hardcover
  • Copyright: 7/26/2010
  • Publisher: WILEY
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Summary

Every person working in an investment bank or hedge fund has a large part of his work connected to the lifecycle of a trade. It is the glue by which all the departments are bound and the aggregated success or failure of each trade determines the survival and growth of the entire organization. Trading has evolved from a humble apple grower wanting a stable price for his produce come harvest time, to a complex and exciting industry comprising a significant share of the global economy, and more recently, taking a hand in saving it. It is the fundamental activity of investment banks, hedge funds, pension funds and many other financial companies. There is no better way to understanding the workings of a financial institution than to follow the progress of a trade through all of its various stages and all the activities performed upon it.In the aftermath of the financial crisis, the financial world has changed, with less emphasis on trading and entrepreneurial activity and more on risk management, regulation and auditing. In this new world order, there will be a much greater analysis of every trade, and all market participants will need to have a much better understanding of the impact of their work on the whole trade cycle.This book will dissect a trade into its component parts, track it from pre-conception to maturity and how the trade effects each business function of a financial institution. As well as illustrating each part of the trade process, it will highlight the legal, operational, liquidity, credit and market risks to which the trade is exposed. Readers will benefit from a full understanding of all parts of the trade process, including derivative and credit derivative trades, and will also see, with examples where appropriate, how the mismanagement of these risks led to today's financial crisis. Table of ContentsHow and why do people trade The trade lifecycle Who acts on a trade How might a trade change during its lifetime Dissection of a trade How are trades executed in the market place Derivatives Credit Derivatives Price and liquidity Risk management Data - the raw material Systematic solutions

Author Biography

Robert Baker has spent the majority of his working life in the financial services industry. He has worked at major investment banks such as Barclays Capital, ABN Amro, UBS Warburg, NatWest Markets and Rabobank as well as the Hedge Fund Solent Capital. He has developed risk management and valuation systems across most asset classes, specializing in credit derivatives.

Holding positions as programmer, project manager, business analyst and head of technology he has worked in IT, from office and quantitative groups. Using his knowledge of software, financial products and the way investment banks and hedge funds operate; he has bee able to interface between all of the business functions to ensure accurate gathering and delivery of system requirements.

In recent years, Robert has moved into consultancy helping a range of companies in the financial sector to maximize their use of IT and advising software vendors on how to tailor their products to meet client expectations.

Robert holds an MA in mathematics from the University of Oxford.

The author can be contacted by email at robert.baker@elmcroft.net

Table of Contents

Preface
Author's Note
Acknowledgements
Products and the Background to Trading
Trading
How and why do people trade?
Factors affecting trade
Market participants
Means by which trades are transacted
When is a trade live?
Consequences of trading
Trading in the financial services industry
What do we mean by a trade?
Who works on the trade and when?
Summary
Risk
Introduction
Risk is inevitable
Quantifying risk
Methods of dealing with risk
Managing risk
Problems of unforeseen risk
Summary
Asset Classes
Interest rates
Foreign exchange (FX)
Equity
Bonds and credit
Commodities
Trading across asset classes
Summary
Derivatives, Structures and Hybrids
What is a derivative?
Linear
Nonlinear
Some option terminology
Option valuation
Exotic options
Structures and hybrids
Importance of simpler products
Trade matrix
Summary
Credit Derivatives
Introduction
CDS
CLN
CDO
Data relating to CDOs
Practical aspects of CDO management
Practical aspects of CDO valuation
Why are credit derivatives different?
Summary
Liquidity, Price and Leverage
Liquidity
Price
Leverage
The Trade Lifecycle
Anatomy of a Trade
The underlying
General
Economic
Sales
Legal
Booking
Counterparty
Timeline
Lifecycle
Pre Execution
Execution and booking
Confirmation
Post booking
Settlement
Overnight
Changes during lifetime
Reporting during lifetime
Exercise
Maturity
Example trade
Summary
Cashflows and Asset Holdings
Introduction
Holdings
Value of holding
Reconciliation
Consolidated reporting
Realised and unrealised P&L
Diversification
Bank within a bank
Custody of securities
Risks
Summary
Risk Management
Traders
Risk control
Trading management
Senior management
How do risks arise?
Different reasons for trades
Hedging
What happens when the trader is not around?
Types of risk
Trading strategies
Hedging strategies
Summary
Market Risk Control
Various methodologies
Need for risk
Allocation of risk
Monitoring of market risk
Controlling the risk
Responsibilities of the market risk control department
Limitations of market risk departments
Regulatory requirements
Summary
Counterparty Risk Control
Reasons for non fulfilment of obligations
Consequences of counterparty default
Counterparty risk over time
How to measure the risk
Imposing limits
Who is the counterparty?
Collateral
Activities of the counterparty risk control department
What are the risks involved in analysing credit risk?
Payment systems
Summary
Accounting
Balance sheet
Profit and loss account
Financial reports for hedge funds and asset managers
P&L Attribution
Benefits
The process
Example
Summary
Systems and Procedures
People
Traders
Trading assistants
Structurers
Sales
Researchers
Middle office
Back office (operations)
Quantitative analyst
Information technology
Legal
Model validation
Market risk control department
Counterparty risk control department
Finance
Internal audit
Compliance
Trading manager
Management
Human risks
Summary
Developing Processes for New Products (and Improving Processes for Existing Products)
What is a process?
The status quo
How processes evolve
Inventory of current systems
Coping with change
Improving the situation
Inertia
Summary
New Products 175
Origin of new products
Trial basis
New trade checklist
New product evolution
Risks
Summary
Systems
What makes a good system?
IT procurement
System stakeholders
The IT team
Timeline of a project
Project management
The IT divide
Techniques and issues related to IT
Systems architecture
Different types of development
Buy versus build
Software vendors
Performance
Project estimation
General thoughts on IT
Summary
Testing
What is testing?
Why is testing important?
Who does testing?
When should testing be done?
What are the types of testing?
Fault logging
Risks
Summary
Data
Common characteristics
Database
Types of data
Bid/offer spread
Curves and surfaces
Sets of market data
Back testing
How can data go wrong?
Typical data sources
How to cope with corrections to data
Data integrity
The business risks of data
Summary
Reports
Introduction
What makes a good report?
Reporting requirements
When things go wrong
Redundancy
Control
Enhancement
Security
Risks
Summary
Calculation
What does the calculation process actually do?
The calculation itself
Sensitivity analysis
Bootstrapping
Calculation of dates
Calibration to market
Testing
Integrating a model within a full system
Risks associated with the valuation process
Summary
Mathematical Model and Systems Validation
Testing procedures
Implementation and documentation
Summary
Regulatory, Legal and Compliance
Regulatory requirements
Legal
Compliance
Risks
Summary
Business Continuity Planning
What is business continuity planning?
Why is it important?
Types of disaster
How does it work?
Risks associated with BCP
Summary
What Can Go Wrong, the Credit Crisis
Credit Derivatives and the Crisis of 2007
Background
The events of mid-2007
Issues to be addressed
Summary
Appendix: Summary of Risks
General comment - unforeseen risk
Operational risk (in the trade lifecycle)
Human risks
Market risk control
Counterparty risk control
Cashflow
Data
Reporting
New products
Legal and regulatory
Testing
Business continuity planning (BCP)
Valuation and model approval
Management
Documentation
Front office
Research
IT and systems
Effective control and support
Recommended Reading
Index
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