The Trade Lifecycle

Behind the Scenes of the Trading Process

Robert P. Baker

• Publisher: Wiley
• Year: 2015
• Print ISBN: 9781118999462
• eBook ISBN: 9781119003687
• Edition: 2
• Topic: Business
• Subtopic: Finance
• Index: Business

Drive profit and manage risk with expert guidance on trade processing

The Trade Lifecycle catalogues and details the various types of trades, including the inherent cashflows and risk exposures of each. Now in its second edition, this comprehensive guide includes major new coverage of traded products, credit valuation adjustment, regulation, and the role of information technology. By reading this, you'll dissect a trade into its component parts, track it from preconception to maturity, and learn how it affects each business function of a financial institution. You will become familiar with the full extent of legal, operational, liquidity, credit, and market risks to which it is exposed. Case studies of real projects cover topics like FX exotics, commodity counterparty risk, equity settlement, bond management, and global derivatives initiatives, while the companion website features additional video training on specific topics to help you build a strong background in this fundamental aspect of finance.

Trade processing and settlement combined with control of risk has been thrust into the limelight with the recent near collapse of the global financial market. This book provides thorough, practical guidance toward processing the trade, and the risks and rewards it entails.

• Gain deep insight into emerging subject areas
• Understand each step of the trade process
• Examine the individual components of a trade
• Learn how each trade affects everything it touches

Every person working in a bank is highly connected to the lifecycle of a trade. It is the glue by which all departments are bound, and the aggregated success or failure of each trade determines the entire organization's survival. The Trade Lifecycle explains the fundamentals of trade processing and gives you the knowledge you need to further your success in the market.

Part One

Products and the Background to Trading

Chapter 1
Trading

In this chapter we introduce the concept of trading which underpins the whole book and go on to look at factors influencing trading, market participants, how trading occurs and related topics.

1.1 How and why do people trade?

People engage in trade primarily for one or more of the following reasons:

• Require more or less of a product
  We go shopping because we need things. The same is true of financial products. One person buys something that another person has in surplus and is prepared to sell.
• To make profit
  If someone anticipates that he can buy for less than he can sell and has the ability to hold a product long enough to take advantage of the price differential, he trades.
• To remove risk
  Sometimes we need protection. We are worried that future events may cause our position to deteriorate and we therefore buy or sell to reduce our risk. The ship is safe, fully loaded in port today, but how will it fare exposed to the open sea tomorrow?

1.2 Factors affecting trade

In order to understand trading we will proceed to discuss the motivation behind why trading occurs.

Product appetite

Everybody wants to buy as cheaply as possible, but some people have a greater need for a product and will be willing to pay more for it. Our appetite for a product will determine the price at which we buy. Conversely, our desire to divest ourselves of a product will affect the price at which we are prepared to sell.

Risk appetite

Risk is not necessarily an undesirable concept. Different people and organisations have a different attitude to risk. Some people make money by owning and managing risk. They are prepared to service other people's desire to reduce risk. Many trades arise because some people will pay money to reduce risk and others will accept money for taking on risk.

Exposure

Whenever a trade occurs, both counterparts have each increased and reduced their exposure to something. For example, if Company A buys yen and sells euros to Company B, then A has increased its exposure to yen and decreased its exposure to euros and B has done the opposite (see Table 1.1).

Table 1.1 How a trade affects currency exposure

Item	Exposure for buyer (Company A)	Exposure for seller (Company B)
EUR JPY	Increased Decreased	Decreased Increased

The EUR-JPY foreign exchange transaction has resulted in the trading of one exposure for another.

Even when something is bought for money, the seller has increased his exposure to the currency of the money he receives. Someone living in New York and trading in dollars does not consider receiving more dollars as a risk because he is not exposed to changes in exchange rates. But in international commerce most market participants do worry about exposure to all currencies including their domestic currency which may attract less deposit interest than an alternative, making holding money in that currency less attractive.

1.3 Market participants

We use the example of a forward trade to illustrate various market participants. Other trades such as spot trades (immediate buy and sell) and options (rights to buy and sell in the future) have similar participation.

Producer

Imagine an apple grower owning a number of orchards. His product sells once a year and his entire income is dependent upon the size and price of his harvest. He can take steps to maximise his crop but he can do little to predict or control the price. He would rather have a fixed and known price for his produce than be subject to the vagaries of the market price at harvest time. How does he achieve a fixed price? He enters into a forward trade with a speculator obliging him to supply a fixed quantity of apples in return for a guaranteed price. He has now removed price uncertainty (or risk) and can concentrate on producing enough apples to meet his obligation.

Consumer

A cider manufacturer requires a certain supply of apples in six months' time. He is willing to pay more than the current market value to guarantee fresh stock is available when it is useful to him. His desire is to reduce his exposure to fluctuation of supply.

Speculator

A speculator takes a view on the likely direction of price change. If he sees a future shortage of apples, he will buy forward contracts now and hope to take advanta...

Table of contents

• Cover
• Series
• Title Page
• Copyright
• Dedication
• Foreword from the First Edition
• Foreword to the Second Edition
• Preface
• Acknowledgements
• About the Author
• Part One: Products and the Background to Trading
• Part Two: The Trade Lifecycle
• Part Three: What Really Happens
• Part Four: Behind the Scenes
• Part Five: Summary of Risks
• Appendix A: Operational Risks
• Appendix B: Human Risks
• Appendix C: Control Risks
• Appendix D: Processing Risks
• Appendix E: Organisational Risks
• Recommended Reading
• Index
• EULA