commercial banks like FX !! eq|comm

banking & economy

FX is closer to the everyday business of commercial banks. The biggest FX banks are usually commercial banks — DB, Barclays, Citi, never ibanks.

FI is a composite market. Some FI products are closer to commercial banks. I think commercial banks buy-n-hold (not trade) sovereign bonds similar to insurers do.

[13] U.S. vs Singapore economies

I used to feel Singapore economy is less stable than North America, Japan and Western Europe. Even a small European economy like Belgium or Finland is in a safer position than Singapore because it’s a stable, integral part of a large, strong ecosystem. These western economies have experienced relatively low or negative growth, persistent unemployment, high national debt, aging population, diminishing manufacturing competitiveness under competition from emerging economies, …. but "strong" means they can withstand bigger adversities longer. Strong means economic competitive advantage over the developing countries.

Now I see signs of U.S. economic status in decline. However, positive signs are still visible — in high tech, new/old media, life science, aerospace, innovation, advanced R&D, energy, material science…. I feel the next 10 years may see further decline in USD and U.S. GDP relative to rest of the world.

In contrast, over 30 years, I feel S’pore is still too small to be strong. S’pore government has to make all the right decisions to avoid the many potential disasters (i won’t list them). Being small, I feel S’pore would suffer quite badly from even a mild misstep. (Sorry no specific examples.)

For big or small economies, every country needs to stay competitive and stay relevant, and identify new growth sectors every 20 years. Just witness the current decline of Nokia and BlackBerry. Nortel is another high-tech example — once the biggest company in Canada. Creative Technology, DEC too. I guess AOL is another cautionary tale of staying relevant. The software industry is even more unforgiving and littered with even more dinosaurs compared to hardware or telecom industries.

Perhaps Singapore would fall on a similar path, but there’s opportunity of renewal…

For a big country like the U.S., renewal seems inevitable. Is there a major sector in U.S. economy that may decline and never recover again? Maybe the railway, steel and garment industries of the past?

[20]hedge fund AUM ranking: confusing #BW,Ren,AQR

Note AUM fluctuates year by year, as hot money flows between hedge funds..

— Based on ( has a similar ranking.)

Many hedge fund managers also manage public funds and offer non-hedge fund strategies. To compare two hedge funds’ AUM, one can use

  • AUM in private funds — world top-10 are typically 30-70b in size. Bridgewater (an outlier, along with Renaissance) is #1 managing $132b
    • Man group ($60b+) is biggest in Europe in this respect
    • Citadel ($30b+) is biggest Chicago manager in this respect
  • AUM in public mutual funds following hedge fund strategies — AQR is #1 managing $172b including $60b in private funds.
  • AUM across all type of funds — Blackrock is #1 managing $6400b uses a different criteria and includes ibanks’ asset-management arms.

MS stronghold domains

  • Advisory is the business that Morgan Stanley is perhaps best known for, and is traditionally strongest in. I think this includes big deals like M&A and IPO. MS is a top-2 player along with GS.
  • As of 2018, IB and PWM contribute to similar amounts.
  • Trading business — as a sell-side player, MS is market leader in equities (IED).

fascinated by analysis@fail`tech brands

I tend to learn something (very indirectly) about competition, churn, focus, …

  • Nokia — refocused on its traditional strength in telecom infrastructure
  • Erickson
  • RIM
  • Yahoo
  • Novell

I feel my choice of java and c++ have been good, but regret my investment in dotnet, pthreads

I feel any dominant technology can get displaced. A few examples (not intended to be complete) — C/C++ (by java), RDBMS, Solaris (by Linux)

My tech bets for 2019-2020:

  1. system knowledge #CSY
  2. socket
  3. c++ TMP — a pure QQ domain for IV muscle-building
  4. c++ threading

ETF share creation #over-demand context is detailed.

Imagine a DJ tracking ETF by Vanguard has NAV=$99,000 per share, but is trading at $101,000. Overpriced. So the AP will jump in for arbitrage — by Buying the underlying stocks and Selling a single ETF unit. Here’s how AP does it.

  1. AP Buys the underlying DJ constituent stocks at the exact composition, for $99,000
  2. AP exchanges those for one unit of ETF from Vanguard.
    1. No one is buying the ETF in this step, contrary to the intuition.
    2. So now a brand new unit of this ETF is created and is owned by the AP
  3. AP SELLs this ETF unit on the open market for $101,000 putting downward pressure on the price.

Q: So how does the hot money get used to create the new ETF shares?
A: No. The hot money becomes profit to the earlier ETF investors. AP also receives the hot money when selling the creation units on open market. The ETF providers don’t receive the hot money.

zero sum game #my take

“Zero sum game” is a vague term. One of my financial math professors said every market is a zero sum game. After the class I brought up to him that over the long term, the stock (as well as gov bond) market grows in value [1] so the aggregate “sum” is positive. If AA sells her 50 shares to BB who later sells them back to AA, they can all become richer. With a gov bond, if you buy it at par, collect some coupons, sell it at par, then everyone makes money. My professor agreed, but he said his context was the very short term.

Options (if expired) and futures look more like ZSG to me, over any horizon.

If an option is exercised then I’m not sure, since the underlier asset bought (unwillingly) could appreciate next day, so the happy seller and the unwilling buyer could both grow richer. Looks like non-zero-sum-game.

Best example of ZSG is football bet among friends, with a bookie; Best example of NZSG is the property market. Of course we must do the “sum” in a stable currency and ignore inflation.

[1] including dividends but excluding IPO and delisting.

book value of leverage

Simple definition of book-value according to Wikipedia — Assets such as buildings and equipment are valued based on their initial acquisition cost.

Now we focus on book value of leverage. A simple analog is the leverage of a property bought on an (unsecured) commercial loan

Suppose the house was bought for $600k with $480k loan. After a few years, loan stays at $480 (to be paid off at maturity), but house doubles to $1.2m.

Book value of EQ is still 600-480 = $120k, but current EQ would be 1.2m – 480k = 720k.

The book value of leverage was and is still 600/120 = 5.0. In contrast, The current value of leverage would be (1200k)/720k, which is lower and safer than book value of leverage.
Now the bleak picture — suppose AS value drops from 600k to 500k. Book leverage remains 600/120 = 5.0. In contrast, Current value of leverage is 500/(500 – 480) = 25.0. Dangerously high leverage. Further decline in asset valuation would wipe out equity and the entire account is under water. Some say the property is under-water but i feel really we are talking about the borrower i.e. owner of the property — i call it the “account”.
(Book value of) Leverage in “literature” is defined as(book value of) ASset / EQuity (book value)


   (LIability + EQ) / EQ …. (all book values)

The denominator is much lower as book value than the current value. For a listed company, Current value of total equity is total market cap == current share price * total shares issued so far. In contrast, Book value is the initial capital of the founder + actual dollars raised through the IPO, ignoring the increase in value of each share. Why is this book value less useful? We need to understand the term “shareholder equity”.  This term logically means the “value” of the shares held by the shareholders (say a private club of …. 500 teachers). Like the value of your house, this “value” increases over time.

Export Credit Agency — some basics

Each national government has such an “exin bank”, funded by the ministry of finance. (There are also some multinational exin banks like Asian Dev Bank, World Bank…) Their mandate is to support their own exporters in terms of *default risk*. The ECA guarantees to the supplier that even if the overseas client (importer) defaults, the ECA would cover the supplier. It’s technically a loan to the importer, to be paid back. For those non-commercial risks affecting large deals (up to several billion dollars), the ECA’s have a natural advantage over commercial banks – they are financed by the government and can deal with the political and other risks across the borders.

Political risk is quite high, but the guarantee fee charged by ECA is very low. This paradox disappears if you understand that those big deals support domestic job creation, and tax/revenue generation of the large national exporters, so even if the fee charged by the ECA is arguably insufficient to cover the credit risk they take on, the decision still make sense. I think these ECA’s are using tax-payer’s money to help the home-grown exporters.

However, the ECA won’t blindly give big money to unknown foreign importers. Due diligence required.

The ECA’s are usually profitable on the back of those fees they charge (something like 1% above Libor). I guess the default intensity is statistically lower than feared, perhaps thanks to the risk analysis by the various parties. Risk assessment is the key “due diligence” and also the basis of the pricing. The #1 risk event being assessed is importer default. The exporter (supplier) are invariably blue chip corporations with a track record, and know what they are doing. 80% of the defaults (either by importer, exporter or the lending bank) are due to political risk, rather than commercial risk.

Many entities take part in the risk assessment, bringing with them special expertise and insight. The commercial bank has big teams dealing with ECA; the exporter needs to assess the buyer’s credit; the ECA has huge credit review teams… There are also specialist advisory firms who do not lend money. If any one of them identifies a high risk they can’t quantify and contain, I would say it’s only logical and prudent to hesitate.

The exporter first approach a (or a group of) commercial bank(s). The bank would seek *guarantee* from the national ECA. The guarantee covers 90% to 100% of the bank loan, so the bank has a very small credit exposure. (The ECA themselves have very high credit rating.) In the event of a default, the bank or exporter would be compensated by the ECA.

They mostly cover capital goods export, such as airplanes/trains/ships, power plants, infrastructure equipment, with long term repayment … So the supplier are mostly blue chip manufacturers. These loans are tricky because

· Long term, so event risk is much higher

· The entity to assess is a foreign entity, often in a developing country

· Big amount, so potential financial loss is sometimes too big for a single commercial lender

China, Japan and Korea are some of the biggest exporter nations.

interest rate hike hitting FX rate

I feel in most major economies the central bank manages interest rate which directly affects FX rate. FX rate doesn't affect interest rate, not directly. — higher interest rates attract foreign capital and cause the currency to appreciate. — Higher interest rates cause an appreciation. – When interest rates go up, so do yields for assets denominated in that currency; this leads to increased demand by investors and causes an increase in the value of the currency in question.

Rate hike leads to inflation, which hurts the currency in question?

Rate hike hurts corporations (including exporters) and balance of payment. Would hurt the currency in question? I doubt it.

Fed rate hike is carefully managed based on growth data. Therefore, rate hike is conditional on US recovery, which means stronger USD.

Economic growth could also mean reduced government bond issue i.e. reduced QE, i.e. slower national debt growth which helps the USD.

beta definition in CAPM – confusion cleared

In CAPM, beta (of a stock like ibm) is defined in terms of
* cov(ibm excess return, mkt excess return), and
* variance of ibm excess return

I was under the impression that variance is the measured “dispersion” among the recent 60 monthly returns over 5 years (or another period). Such a calculation would yield a beta value that’s heavily influenced or “skewed” by the last 5Y’s performance. Another observation window is likely to give a very different beta value. This beta is based on such unstable input data, but we will treat it as a constant, and use it to predict the ratio of ibm’s return over index return! Suppose we are lucky so last 12M gives beta=1.3, and last 5Y yields the same, and year 2000 also yields the same. We still could be unlucky in the next 12M and this beta
fails completely to predict that ratio… Wrong thought!

One of the roots of the confusion is the 2 views of variance, esp. with time-series data.

A) the “statistical variance”, or sample variance. Basically 60 consecutive observations over 5 years. If these 60 numbers come from drastically different periods, then the sample variance won’t represent the population.

B) the “probability variance” or “theoretical variance”, or population variance, assuming the population has a fixed variance. This is abstract. Suppose ibm stock price is influenced mostly by temperature (or another factor not influenced by human behavior), so the inherent variance in the “system” is time-invariant. Note the distribution of daily return can be completely non-normal — Could be binomial, uniform etc, but variance should be fixed, or at least stable — i feel population variance can change with time, but should be fairly stable during the observation window — Slow-changing.

My interpretation of beta definition is based on the an unstable, fast-changing variance. In contrast, CAPM theory is based on a fixed or slow-moving population variance — the probability context. Basically the IID assumption. CAPM assumes we could estimate the population variance from history and this variance value will be valid in the foreseeable future.

In practice, practitioners (usually?) use historical sample to estimate population variance/cov. This is, basically statistical context A)

Imagine the inherent population variance changes as frequently as stock price itself. It would be futile to even estimate the population variance. In most time-series contexts, most models assume some stability in the population variance.

capm – learning notes

capm is a “baby model”. capm is the simplest of linear models. I guess capm popularity is partly due to this simplicity. 2 big assumptions —
Ass1a: Over 1 period, every individual security has a return that’s normal i.e. from a Gaussian noisegen with a time-invariant mean and variance.

Ass1b: there’s a unique correlation between every pair of security’s noisegen. Joint normal. Therefore any portfolio (2 assets or more) return is normal.

Ass2: over a 2-period horizon, the 2 serial returns are iid.

In the above idealized world, capm holds. (All assumptions challenged by real data.) In real stock markets, these assumptions could hold reasonably well in some contexts.

capm tries to forecast expected return of a stock (say google). Other models like ARCH (not capm) would forecast variance of the return.

Expected return is important in the industry. Investors compare expected return. Mark said the expected return will provide risk neutral probability values and enable us to price a security i.e. determine a fair value.

Personally, i don’t have faith in any forecast over the next 5 years because I have seen many forecasts failing to anticipate crashes. However, the 100Y stock market history does give me comfort that over 20 years stock mkt is likely to provide a positive return that’s higher than the risk-free rate.

Suppose Team AA comes up with a forecast mkt return of 10% over the next 12 months. Team BB uses capm to infer a beta of 1.5 (often using past 5 years of historical returns). Then using capm model, Team CC forecasts the google 12M expected return to be 1.5 * 10%.

In the idealized world, beta_google is a constant. In practice, practitioners assume beta could be slow-changing. Over 12M, we could say 1.5 is the average or aggregate beta_google.

Personally I always feel expected return of 15% is misleading if I suspect variance is large. However, I do want to compare expected returns. High uncertainty doesn’t discredit the reasonable estimate of expected return.

“Market portfolio” is defined as the combined portfolio of all investor’s portfolios. In practice, practitioners use a stock index. The index return is used as mkt return. Capm claims that under strict conditions, 12M expected return on google is proportional to 12M expected mkt return and the scaling factor is beta_google. Capm assumes the mkt return and google return are random (noisegen) but if you repeat the experiment 99 million times the average returns would follow capm.

UIP carry trade n risk premium

India INR interest could be 8.8% while USD earns 1.1% a year. Economically, from an asset pricing perspective, to earn the IR differential (carry trade), you have to assume FX risk, specifically the possible devaluation of INR and INR inflation during the hold period. 

In reality, I think INR doesn't devalue by 7.7% as predicted by UIC, but inflation is indeed higher in India.
In a lagged OLS regression, today's IR differential is a reasonable leading indicator or predictor of next year's exchange rate. Once we have the alpha and beta from that OLS, we can also write down the expected return (of the carry trade) in terms of today's IR differential. Such a formula provides a predicted excess return, which means the carry trade earns a so-called “risk premium”. 
Note, similar to the DP, this expected return is a dynamic risk premium (lead/lag) whereas CAPM (+FamaFrench?) assumes a constant time-invariant expected excess return.. 

benchmark a static factor model against CAPM explains …

Let me put my conclusion up front — now I feel these factor models are an economist's answer to the big mystery “why some securities have consistently higher excess return than other securities.” I assume this pattern is clear when we look long term like decades. I feel in this context the key assumption is iid, so we are talking about steady-state — All the betas are assumed time-invariant at least during a 5Y observation window.

There are many steady-state factor models including the Fama/French model.

Q: why do we say one model is better than another (which is often the CAPM, the base model)?

1) I think a simple benchmark is the month-to-month variation. A good factor model would “explain” most of the month-to-month variations. We first pick a relatively long period like 5 years. We basically “confine” ourselves into some 5Y historical window like 1990 to 1995. (Over another 5Y window, the betas are likely different.)

We then pick some security to *explain*. It could be a portfolio or some index of an asset class.

We use historical data to calibrate the 4 beta (assuming 4 factors). These beta numbers are assumed steady-state during the 5Y. The time-varying (volatile) factor values combined with time-invariant constant betas would give a model estimate of the month-to-month returns. Does the estimate match the actual returns? If good match, then we say the model “explains” most of the month-to-month variation. This model would be very useful for hedging and risk management.

2) A second benchmark is less intuitive. Here, we check how accurate the 2 models are at “explaining” _steady_state_ average return.

Mark Hendricks' Econs HW2 used GDP, recession and corp profits as 3 factors (without the market factor) to explain some portfolios' returns. We basically use the 5Y average data (not month-to-month) combined with the steady-state betas to come up with an 5Y average return on a portfolio (a single number), and compare this number to the portfolio actual return. If the average return matches well, then we say …”good pricing capability”!

I feel this is an economist's tool, not a fund manager's tool. Each target portfolio is probably a broad asset class. The beta_GDP is different for each asset class.

Suppose GDP+recession+corpProfit prove to be a good “pricing model”, then we could use various economic data to forecast GDP etc, knowing that a confident forecast of this GDP “factor” would give us a confident forecast of the return in that asset class. This would help macro funds like GMO making asset allocation decisions.

In practice, to benchmark this “pricing quality”, we need a sample size. Typically we compare the 2 models' pricing errors across various asset classes and over various periods.

When people say that in a given model (like UIP) a certain risk (like uncertainty in FX rate movement) is not priced, it means this factor model doesn't include this factor. I guess you can say beta for this factor is hardcoded to 0.

risk premium — clarified

risk premium (rp) is defined as the Expected (excess) return. A RP value is an “expected next-period excess return” (ENPER) number calculated from current data, using specific factors. A RP model specifies those factors and related parameters.

Many people call these factors “risk factors”. The idea is, any “factor” that generates excess return must entail a risk. If any investor earns that excess return, then she must be (knowingly/unknowingly) assuming that risk. The Fama/French value factor and size factor are best examples.

Given a time series of historical returns, some people simply take the average as the Expected. But I now feel the context must include an evaluation date i.e. date of observation. Any data known prior to that moment can be used to estimate an Expected return over the following period (like12M). Different people use different models to derive that forward estimate i.e. a prediction. The various estimates create a supply/demand curve for the security. When all the estimates hit a market place, price discovery takes place.

Some simple models (like CAPM) assumes a time-invariant, steady-state/equilibrium expected return. It basically assumes that each year, there’s a big noisegen that influences the return of each security. This single noisegen generates the return of the broad “market”, and every security is “correlated” with it, measured by its beta. Each individual security’s return also has uncertainty in it, so a beta of 0.6 doesn’t imply the stock return will be exactly 60% of the market return. Given a historical time series on any security, CAPM simply takes the average return as the unconditional, time-invariant steady-state/equilibrium estimate of the steady-state/equilibrium long-term return.

How do we benchmark 2 steady-state factor models? See other blog posts.

Many models (including the dividend-yield model) produce dynamic estimates, using a recent history of some market data to estimate the next-period return. So how do I use this dynamic estimate to guide my investment decisions? See other posts.

Before I invest, my estimate of that return needs to be quite a bit higher than the riskfree return, and this excess return i.e. the “Risk premium” need to be high enough to compensate for the risk I perceive in this security. Before investing, every investor must feel the extra return is adequate to cover the risk she sees in the security. The only security without “risk premium” is the riskfree bond.

negative beta, sharpe, treynor

corr=1 means perfect positive corr, but doesn't tell us whether a 1 unit increase in X causes a 0.001 or 1000 units increase in Y.

When we compare returns of a fund or stock vs a stock index, we are interested in the relative size of change or “magnifying

effect”. Beta helps here.

A “normal” beta close to 1.0 means when mkt grows[1] 5%, then ibm also grows about 5%. Note this growth is fast-changing. All prices

are volatile. As shown in other posts on beta, many other CAPM variables are not volatile, but could be slow-changing.

[1] assumeing low risk-free rate, so excess return and “return” are practically no-different.

A large beta like 1.5 is more volatile. A “magnifier” stock such as tech stocks. A 5% drop in the index is likely to see a 7.5% drop

in this asset.

Beta < 1 means a "stable" stock that moves in-sync with the market but at very low magnitude.

Negative beta means short positions or something else.

A negative Sharpe ratio indicates your fund underperforms risk-less asset (like a gov bond in your fund's currency). The denominator

(std of the fund return), be it large or small, isn't responsible for this negativity.

Treynor Ratio is negative if

case1: if beta is positive, then fund underperforming risk-free rate.

case2: if beta is negative, then fund outperforming risk-free rate. This means that the fund manger has performed well, managing to

reduce risk but getting a return better than the risk free rate

asset^liability on a bank’s bal sheet

When a bank issues a financial statement, the meaning of AS (asset) and LI (liability) tend to confuse me.

Suppose JPMC bank has client IBM…

Liability – Deposits (incl. CD) at the bank
Liability – overnight borrowing. This interest rate could surge like in 2008.
Liability – Commercial papers issued by the bank
Liability – Bonds issued by the bank
Asset – securities owned by the bank (treasury department?), including stocks, govt bonds and corp bonds etc. Securities could devalue like bad loan!
Asset – Loans to corporations like IBM — on the balance sheet treated like a govt bond!
Asset – Loans/mtg to retail — on the balance sheet treated like a govt bond!
Asset – spare cash

AS = LI + share holders’ equity

If the bank issues 600M shares in an IPO, the $600mil collected is considered share holders’ equity capital or simply “capital” or simply “equity”.

Chronologically, the balance sheet starts with the initial share holders’ equity. Then Deposits come in and sitting there as spare cash. Similarly the bank can issue bonds.
Then the bank could use the spare cash to buy securities — without change on the LI side.
The bank can also use the spare cash to give loans — without change on the LI side.

Each type of transaction above affects the balance sheet only in a “realized” sense i.e. book values —

Big warning – all the AS numbers and LI numbers and equity values are book values.
* Latest share price doesn’t enter the equation. Those 600M shares will always be recorded as worth $600M on the balance sheet.
* market value (m2m) of the loans lent out doesn’t matter
* market value (m2m) of the securities owned by the bank doesn’t matter.

Fair Value accounting tries to change that. Mark-to-market is a big effort in GS and many investment banks.

5 business models in investment banking

Hi Yi Hai,

Upon your suggestion, I watched many Tim's videos including this one ( about the 5 business models in investment banking. Very good framework. I have a few inputs to add on his 5 items —

1) prop trading
2) market making
3) M&A
4) Underwriting
5) structured products

1) is the only BuySide business model among Tim's 5 items. In many investment banks, there's actually another buy-side business unit in the form of asset management. They often run big mutual funds and hedge funds.

2) is not the only way a investment bank makes money on the Security markets. Most of them also provide trade facilitation and market access to their big clients. A 3rd major business in this domain is block trading. A big client hoping to sell 500,000 shares of IBM would send the RFQ to 3 investment banks. Once UBS provides a quote and gets selected, it must execute at the agreed price (even if at a loss, if market moves quickly against it.)

5) SP is not a separate business unit in many investment banks I worked with. I guess each trading desk often has a structured product team. Tim made me realize this is probably a 4th business model under the umbrella of Securities business. In Singapore, a lot of commercial banks sell structured products to consumers and businesses, but there could be an investment bank behind the scenes doing the structuring.

3) Besides M&A, there are privatization deals, spin-off deals, Management-Buy-Out deals etc. Very often the advisory bank must lend money to the client.

4) Tim actually used the term “new issue”, including bond IPO and stock IPO.

In addition, Prime Brokerage is another big business for many investment banks. The PB department often brings business to the Securities department (since the hedge fund clients often sends in orders) but PB revenue is more than that, based on what I heard.

capital control, exchange rate regulation #basics

Treat the currency of a country (say JPY) as paper money or electronic money. Capital control attempts to monitor and regulate the outflow of every JPY.

Electronic flow is probably easier to regulate. I think all the electronic systems are operated by heavily regulated agencies.

Outflow can be conversion of JPY 1mil into EUR.
Outflow can also be fund transfer into a JPY account in Brazil, without currency conversion.

Case in point — FDI often brings in foreign currency, invest, profit (in local currency)… then they want to bring the profit out of the country — outflow. They need to convert or transfer.

To be effective, the system also needs capabilities to stop a particular outflow when necessary.

Q: how effective is capital control?
A: quite effective

Q: what are the capital outflow avenues for corporations (foreign or domestic)?
A: usually through banks. It’s easier and more effective to regulate banks than corporates.

Q: what are the capital outflow avenues for individuals?
A: for small amounts they can change with friends, but large amounts often go through regulated agencies.

Q: what are the capital outflow avenues for crime gangs?
A: murky underground tunnels.

Q: how many loopholes?

Is a pure-play investment bank really a bank@@

Many people wonder why the word “bank” in “investment-bank”. I mean, do those Goldmans and Morgans have anything in common with the main street banks, such as the savings banks or commercial banks? Well, I see  some non-trivial similarities.

Similarity – service provider and facilitator. Like a commercial bank, an investment bank is supposed to facilitate clients’ financial strategies. This is obvious in the IB business model (below). It’s less clear in the SS model (below). In an ideal world, an investment bank in its SS role should not do the buy-side type of business (prop-trading) and compete with clients. This ideal world doesn’t exist, but most investment banks do look like sell-side service providers.

Similarity – lending. Like all banks, an investment bank lends money all the time, and it also borrows money from investors (“depositors”) and central banks.

The IB business model described below has so much in common with commercial banking that most of the major investment banks today are part of commercial banks. This model is known as universal banking, adopted by Citi, Barclays, JMPC, UBS/CS, HSBC/SCB/RBS, DB, BNP/SG, RBC etc. If we focus on the investment banking business on its own, there are basically 2 main business models —

IB — The traditional meaning of IB is related to “funding” and “financing” for a big client’s big project, such as a merger or privatization but more commonly bond/equity issue, including public issues a.k.a. IPOs. These are often dressed up, packaged as “advisory business”, but what clients need most is financing, as illustrated in the Napoleonic wars. In such a funding project, the IB does something similar to a regular bank – collect funds from a large number of investors and lend to that particular client. However, the risks, expertise, techniques, operations, competitive strategies … tend to be different from regular commercial banking.

SS — The other major IB business model is playing the sell-side on security markets. This is not just passive order-taking. Many players are also in the business to create structured products. They have an advisory team to actively engage prospective clients and customize their products for each client. See other posts in this blog.

All other IB business models are lesser known but could sometimes generate more profit than the 2 main models
– asset management — buy-side business model
– prime brokerage
– security lending
– clearance
– investment research

gold standard#3:devalue,print-money,export..

Every functioning economy needs to Print money, basically creating more paks out of thin air, assuming your currency is the “pak”. It becomes a problem only when we print too much. But too much compared to …. To the amount of export earning and your “gold” reserve.

Initially, each pak is backed by a microgram of gold. Assume our country has no gold mine, so when you print 5% more packs, you need to “earn” 5% more gold by exporting. If you earn less, and print more, then it’s no longer possible for every pak in circulation to be backed by a microgram of gold. The pak would devalue against gold.

According to P359 CFA Econ textbook, Each pak paper note or coin is officially and legally a claim on the “gold” (i.e. the foreign reserve of gold and hard currencies) of the pak issuer i.e. the central bank. No one else can print paper pak notes. Initially, a pak holder has the right to convert his pak into gold. Such paper money is called convertible paper money.

I think SGD is backed by  a basket of hard currencies – the modern-day equivalent of gold. Every SGD ever “printed” is (not strictly) backed by some amount of “gold” earned from export. Singapore government doesn’t print SGD to solve her own debt problems. Singapore government probably doesn’t need to, thanks to good revenue. Tax revenue is a major component but tax is relatively low in Singapore. I guess revenue also comes from (partially) state-owned companies[1], land sales and sovereign fund investment returns.

[1] I don’t totally agree, but many Singapore residents say that hospitals, residential parking lots, telephone, water, power, gas supplies are all run by state-owned but privatized companies that are profit driven. Some of the largest property developers and largest banks are partially state-owned too.

In the case of Fed reserve bank, the “gold” asset you can claim on consists of
1) real gold
2) basket of hard currencies
3) US gov bonds — biggest component

The fed prints paper money according to the total quantity of these “gold” assets. If too much paper money printed, then the dollar devalues against 1 and 2.

Bear in mind anyone can hold  US gov bonds, but Fed holds so much of it that it is the basis of most of the USD paper money in circulation. Suppose the total USD in circulation is 900 tn. When US government issues 100 tn of bonds, Fed’s reserve would increase by that amount and Fed can print that much USD. However, is the additional quantity of USD ultimately backed by gold? No. I think that’s why USD would weaken against gold.

Once again, I feel gold standard is simplifying assumption. We just need to know when it stops being simplifying and becomes simplistic.

y do commercial banks have lots of money for trading#hearsay

Reason: a commercial bank makes money by lending to (credit worthy) borrowers but ROI of this traditional business model is modest. They get much better ROI from security trading.

Reason: a commercial bank often has excess liquidity. Out of $1b deposit, banks are regulated to lend out perhaps 75% (or 90% — known as LTD ratio) but must keep some 25% of the $1b in liquid cash. If the bank keeps 25.5%, then the .5% is excess liquidity. Note a bank can’t treat (total deposit minus total loan) as excess liquidity. Bank is regulated to keep some liquid cash to satisfy depositor withdrawals.

By default, the excess liquidity cash sits there earning 0 return. Security trading is one way to get some return.

Reason: a commercial bank often has FX risk to hedge. I think FX/derivative trading is one way to hedge. Bank must allocate some capital to the trading desk. Regulators would approve such capital allocation as it’s needed to reduce systemic risk and strengthen stability.

Reason: a commercial bank often has large enterprise customers who need tailor-made financial solutions. (I feel many mainstream derivative products originated in big bank’s structuring desks addressing the needs of big corporates.) When the corporate enters a derivative contract with the bank, the bank must hedge its risk by trading suitable securities on the open market. Bank must allocate some capital to the trading desk.

Reason: many banks started trading using it’s own excess liquidity. Then they realize ROI is sweet, so they started borrowing from other banks purely for security trading. This is another source of trading capital.

commercial banks(like ibanks) can create stress on central bank is an enlightening article.

A regulated savings bank (Say BS-Bank) is a private company but a “privileged” company. Privilege is granted by the central bank (tax payer funded) because of the “public service” nature of this company.

The privilege is a huge guarantee (by the central bank) that if careless loan officers give out many bad loans and lose 99% of the money at BS-Bank, retail depositors will be 100% “covered” by central bank when they withdraw.

To understand the rationale, let’s understand the basic risks facing a bank. Suppose BS-Bank takes in $5B deposits and lends out $25B (fractional reserve banking). If depositors panic and queue up to withdraw, BS-bank runs out of cash. As soon as it fails to hand over a single cent demanded by a depositor, BS-bank is considered insolvent and bankrupt. Such things happened in the 1930’s. Since then, most governments provide that guarantee.

A bank is providing a “public service” — collects deposits from the public and lends out to home buyers, students, small local businesses, local and central government bodies… Therefore, Government feel the need to prop up all such banks. Note investment banks aren’t banks.

The irony in the guarantee — As a private company, a greedy and chaotic bank can take excessive risks, but tax payers (through the central bank) bear the consequences. “taxpayers will provide a buffer to absorb the banks’ losses”, says the BBC article. That’s why these banks are regulated, but I don’t know how effectively.

You might ask how the central banks can “absorb” all the losses. Well it can create money out of thin air and lend to the bank. No free lunch — currency devaluation; inflation; more Treasury bond issues; higher interest cost to the government; ..

Now I know both unregulated investment banks and regulated commercial banks can create stress on central banks.

In 2008, Singapore government basically extended the guarantee beyond retail to all depositors of Singapore based banks.

goldStandard#2:central banks2control FX rate

Q3: For a freely traded currency, how does the CB (central bank) rescue it?
A: basically CB need to spend their “reserve” to buy their own currency. There might be other means (capital control…), but this is the primary means.

Q3b: can this CB ask another CB (say Chinese CB) to help?
A: yes but the other CB must spend its reserve too. Nothing free.

When a currency is under pressure, hedge funds basically assumes [1] CB has limited capacity to save it. Note a CB can’t easily print money. Under attack, a CB has no legal power to print other country’s currencies. If CB prints its own, it weakens further. In other crises, printing money also has serious consequences. Printing money is a sign of hollowness and desperation. Investor Confidence!! Investors (domestic/foreign) will sell or short-sell the currency.

Gold-standard is good simplification with educational value…

[1] (Exception to that assumption) Central banks of smaller economies often protect their currency with another form of “gold standard” — dollar-peg backed by foreign reserve — basket of hard currencies. A hard currency refuses to weaken “randomly”, because that CB has reason and “gold reserve” to maintain it….

“Gold” standard prevents a run on the currency. Remember each SGD owned by a foreigner is a “claim” on Singapore’s reserve. If there’s obviously enough reserve, then no basis for a run.

Gold-standard obviously forbids lavish money-printing.

Gold-standard is a discipline on gov spending, productivity, export growth, wage control, inflation …

“Gold” standard shows why US trade deficit means more dollars flowing to China (claim on US gold…) so “effective US gold reserve” shrinks and dollar holders worry about that reserve — since Fed may print money and devalue the dollar.

“Gold” standard debunks the naive impression that a CB can freely raise the value of its currency so its citizens become richer when visiting overseas. Without discipline, a CB can print money and deposits to citizens’ bank accounts, but immediately purchasing power drops.

“Gold” standard is the simplest (simplistic but fairly true) explanation why hard currencies forex rate appear to be “anchored” despite gigantic daily trading volumes. The anchor is the “gold reserves”.

Gold-standard illustrates the fundamental impact of import/export on forex rates. Does private import/export go through CB? I think it does since the currency used to pay for import ultimately comes from CB. (However money earned by export may not go back to CB! )

Gold-standard clarifies that private bank lending can’t increase money supply as a CB can…

“Gold” standard answers the FAQ why everyone somehow believes paper money represents real buying power.

“Gold” standard sheds lights on how paper money is “backed” by CB…

gold standard #1: inflation etc

In reality, few governments follow the gold standard, but it’s instructive to consider what if they do.

Annual gold mining output is steady and presumably quite low.

If there’s an authority controlling the total number of HK dollars in circulation [1] and that authority ensures every dollar “created” is backed by a fixed quantity of gold in its reserve, and if every country adopts a similar gold standard, then any time we would be able to mathematically convert all the dollars to gold and all the yens to gold…. and the total gold reserve is still less than total physical gold ever “dug up”. This would be a truly effective control on inflation.

Central banks could print currency easily (inflation) when there’s no gold standard, but no CB can suddenly get 10 times more gold. To obtain more gold, the country must export and receive payment in foreign currency, which are legal claims on the gold reserve of that country. In the late 19th century, many colonial powers coerced China to pay “compensation” in the form of gold.

[1] But how does that authority control banks lending huge amounts in dollars therefore creating dollars? I think answer lies somewhere around the regulation. An unregulated private lender (e.g. loan shark, venture capital, pure-play investment banks) can lend $10b and charge an exorbitant interest amount of $1t, but how does the debtor get the $1t to repay? It has to sell something then collect real USD, which is controlled by the authority. When inflation rises to 50% a year, that can only be a central bank action, not a market action.

savings bank making loans


(New thoughts below. We were distracted by “fractional reserve banking” concept, which doesn’t apply to Thomas, OrangeUnion or KS. For a real example, I actually deposited $1600 in Citibank but I know I can’t take out $5000.)

Suppose Thomas is a small venture fund with $2 million of real cash. Thomas likes a start-up called Prism so he invests $2m in Prism. Now Thomas has $0 balance. Thomas likes another start-up CakeHealth, so he invests $1m in CakeHealth.  Both cases, Thomas gives a check from his CapitalOne corporate account. Both start-ups have bank accounts in Chase. When CakeHealth cashes in the $1m check, it bounces.

In theory, CapitalOne may implicitly give Thomas a credit line of $1m when CakeHealth cashes the CapitalOne check drawn against Thomas’s depleted account. Question is how much credit. In fact, since there’s no collateral, I doubt CapitalOne will give the $1m unsecured loan. If CapitalOne were so generous, then many Thomas’s would queue up to take advantage of it — deposit $100k and take out $200k to buy gold. Bank would soon collapse. I know that in reality a commercial bank like CapitalOne looks at each application when handing out loans — not implicitly or automatically approved.

That’s story 1. Now Story 2. Orange bank is a tiny private (unregulated) savings union not registered with Fed or FDIC. It can’t even print checks. OrangeUnion takes deposits from local residents totalling $20m. Depositors mostly use CD’s. Then a McDonald’s franchise shows up to borrow $20m so OrangeUnion lent her. Then KFC wants to borrow $10m and OrangeUnion lent him. Both loans mature in a month and get repaid. Then McDonald’s borrows $22m and KFC $11m, but for 10 years. Now OrangeUnion must be careful because it can’t get the money back quickly. 

But let’s analyze the first OrangeUnion 2 loans. Suppose the $20m deposit is maintained in a Citibank account owned by OrangeUnion. McDonald’s gets the loan amount in a $20m Citibank check. McDonald’s owner deposits that in her corporate account in Citibank (Citi just transfers the $20m from one account into the other.) Then she writes a check of $20m to pay her supplier. No problem. Orange’s Citibank account and McDonald’s bank account both become $0. Now KFC gets the $10m loan from OrangeUnion in a Citibank check and tries to deposit it into KFC’s account with Wachovia. Check Bounce? In that case, this OrangeUnion has absolutely no leverage as a lender. It can only lend out $20m if it has $20m deposit.
I now think OrangeUnion (or Thomas) has no leverage.

Story3 is a regular savings bank — say AppleBank. Somehow AppleBank does have leverage. If it has $20b deposit, it CAN lend out more than that. What’s the real difference between AppleBank and OrangeUnion? I guess answer is the regulation. The central bank gives AppleBank its leverage and central bank has some kind of control over its lending practice.

Story 4 is an investment bank KS. No Fed no FDIC. KS __borrows__ $3b from short term money market, but how can it lend $2b to Shell and then $4b to BP in investment banking deals? Say KS checks are issued from BofA, when both Oil companies take money out of the checks, they will more than deplete the $3b cash KS puts into its account with BofA! The BP check will bounce?

Note KS has to _borrow_ from money market because it can’t freely borrow from central bank — no fractional reserve banking for KS.

another example of Forex-IR interdependency

When a government (Argentina,Greece…) is facing escalating borrowing cost …

It can devalue currency by printing lots of money (Germany in 1923)

It can default (and also devalue currency), like Argentina did around 2002

It can tighten its belt, increase taxes, reduce gov spending like welfare, increase productivity, endure increasing unemployment …

When Argentina’s new bond’s interest rate hits 700bps, why would existing bonds devalue on the secondary market? (Let’s put aside the factor of default risk.) I already discussed this on my blog, but now i feel invariably it’s related to currency depreciation. Rational Investors feel the supply of this currency has to increase and therefore devalue, because the government must print more of this currency to service debt.

But events in late 2011 are different. I’m not sure if currency is even a factor. When Italy’s new bond hits 700bps, we know the Italian government can’t print more euro as ECB is now in control. I would say the main reason for the escalating borrowing cost is default risk. Secondary bond market is unrelated to issuer’s borrowing cost, but here bond yield also increased, probably due to default risk.

One thing for sure — exchange rates, interest rates and credit risk affect each other in many ways.

import/export always involves forex trade#my take

A Chinese toy maker may advertise her products in both RMB and USD, and you may think that Walmart buying these products doesn’t involve any forex transaction.

However, what about the suppliers (and workers, and rent) of the Chinese manufacturer? Those payments must be in the local currency. (Most manufacturers have a margin below 30%, so) typically at least 70% of the money Walmart paid must be converted to RMB sooner or later.

Even the remaining 30% (or less) is often repatriated to local currency as well, but i can only speculate some of the reasons —
– dividend payout or owners taking out profit
– expand the business
– fund a new business

Incidentally, I believe the advertised USD price is often uncompetitive. Walmart (the buyer) gets more competitive prices from a forex dealer bank. Larger amount and higher credit of Walmat’s would help narrow the bid/ask spread. The advertised USD price is either rather high (for smaller customers) or requires a large order size.

deleverage and deposit-taking bank holding company

A common theme in finance — Pure play investment banks push into high leverage to achieve profit margins much higher than commercial banks could. Any Downside?

1) profit is magnified by leverage, so is loss. I guess Lehman collapsed under the weight of leverage.
2) Leverage always requires borrowing. In a credit crunch, cost-of-funding, i.e. borrowing cost could suddenly escalate for no apparent reason.

Leverage means borrow $1m to trade $20m worth of security. Leverage is a power tool in the hands of masters. In Goldman's case, the big share holders are the (skilled) partners. I guess these “masters” decided to push up leverage (with risk control in mind) to increase profit and return on their share holdings.

Investment banks achieved such leverage because they weren't highly regulated and restrained as commercial banks. In 2008, GS and MS abandoned that “freedom” due to Item 2) above. As nominal owners of commercial banks (i.e. bank-holding) , they could now borrow at a much lower rate, probably from the US central bank. I guess the amount they could borrow from government was about a trillion dollars for each bank. See

Commercial banks and universal banks typically borrow at the deposit rate — the rate on your regular savings accounts. In a credit crunch, these banks have trillions of deposit dollars to provide liquidity to themselves (banks), which means these banks could use the deposit dollars to pay creditors. Icing on the cake — in many countries, deposit dollars are insured by governments to protect consumers, and also to reassure depositors not to create a run on a bank.

With more regulation, leverage ratio must reduce, so does profit margin. However, I am not sure if GS or MS had lower profit margins as a result.

Another (related) form of leverage is margin trading and wide spread in
– listed option
– futures
– FX spot, options
– a lot of cash equity trades

trading losses at i-banks — vastly different natures

A $1billion trading loss can mean a lot or mean nothing to an investment bank. Let’s assume a hypothetical full-service investment bank named SS.

$1b trading loss in a SS hedge fund (a subsidiary buy-side run by SS) — assuming SS house money is not invested in the fund(which is rare), then the $1b hit the fund’s clients only. If they start to withdraw, SS will lose management fee income at the end of the quarter. NOT $1b loss in SS balance sheet!

$1b trading loss in a SS prop trading desk — Simple and clear. $1b House money lost.

$1b trading loss in a structured OTC desk — like prop

$1b trading loss in a bond desk which is always a dealership — like prop. “Dealer” is more accurate than “market-maker” or “agency trader”. See

$1b trading loss in exchange agency trading — In this case, SS is THE counter-party to clients. SS takes positions. SS must carefully hedge its exposure to IR, vol, FX, credit risk, sector concentration etc. The $1b loss is bank’s loss, not client’s loss.

?? $1b trading loss in a pass-through brokerage unit in SS — An article on P40 of [[Bloomberg Markets Dec 2008]] confirmed that such a business does exist in an investment bank, but I doubt the brokers would know client’s PnL. This unit takes no position no risk, so should not suffer any loss. See

buy-side/sell-side business units in a bulge bracket

Most “pure-play” investment banks have an asset management arm, often comprising private wealth + private-equity + in-house hedge fund + regular mutual fund management [1]. Crucially, in all of these, the money under management is not [3] primarily house money. House money could be a small part of the money invested in such a fund, but if a fund is entirely made up of house money, then it’s like a prop trading desk. In a way, this is also similar to sovereign funds like Singapore’s GIC.

This Asset Management business is often largely separated from the main business, and often incorporated into a separate entity. Just how separated? A GS buy-side veteran told me a buy-side trader can bypass the sell-side arm of GS and trade with a Barclays sell-side i.e. a competitor to GS. Doing so is unusual, punishable but allowed.

Within the big investment bank, on the other side of the fence lives a giant cousin — the sell-side arm. In all investment banks this is a much larger arm. Within the sell side there’s a Chinese wall. In practice, it’s hard to separate out the individual components therein, but a Chinese-wall is quite common —

– underwriting
– capital restructuring + always some (huge amount of) financing. These deals include M&A, MBO/LBO, privatization, spinoff…

—– Chinese Wall —–

– agency trading
– dealing, usually inventory based
– prime brokerage – extension of “brokerage” business

A few other business units are hard to categorize —
– research,
– clearing service,

Now, a non-pure-play “universal” bank does all of the above + commercial banking —
* retail banking
** credit cards
** mortgage — Note MBS is strictly in the “dealing” business
** retail loans
* corporate banking

Nowadays, investment banks also operate a private bank. Private bank clients can take loans from the bank, but by and large private banks make money mostly from fee-based business i.e. asset management.

[1] where some big players focus exclusively — BlackRock, Pimco, Vanguard, Fidelity,
[3] sometimes a little bit

Fed^treasury department

* By law, the Fed must follow the Treasury’s instructions even if it disagrees with them
* fed is responsible to set interest rate
* Fed is “Fed Reserve Bank” and can buy any stock or any currency — open market operations

Federal Reserve Bank can purchase through its open market operation $10 million worth of Microsoft stock. The bank pays for this
stock with its own check, a Fed check or its electronic equivalent. [The Fed check is created from thin air, there are no funds
backing this check. No funds!] The Fed check is deposited, by the stock seller, into a local bank. It is then returned to the
Federal Reserve Bank where the check is cleared and the local bank is given full credit for this deposit.

central bank rate hikes bring ccy up or down@@

Higher interest rate helps a currency short-term. Inflation (sometimes associated with increasing IR) is sure to weaken a currency. According to Wikipedia — By increasing interest rates a central bank stimulate traders to buy their currency (carry trades) as it provides a high return on investment and this would strengthen the currency against others.

I feel this might reduce inflation and increase purchasing power.When inflation is perceived to rise (easy borrowing), central banks dampen it by rate hikes (expensive to borrow).

Very roughly, Interest rate is 70% influenced by gov; FX rate is 30% influenced by gov. Central bank has 90% control on the supply of their currency (but not other currencies). FX adjustment is one of the goals of Central bank IR actions. IR actions have other serious consequences not to be ignored. In this sense, FX trading desk needs IR expertise.

The interest rate is higher on some currency because there is a probability that it will depreciate. As long as the depreciation does not materialize, the carry trade is profitable, but makes big losses when it does. High yielder currencies aren’t always safe bets.

y commercial banks also have trading systems

I just had a clue to this question.

In general, broker-dealers do trading; Investment banks raise money for clients; commercial banks lend money. (In reality, every investment bank also has a substantial broker/dealer operation, as the money-raising is done on the so-called “capital market”.)

So why do commercial banks (excluding the conglomerate universal banks) need trading systems? This is what I guess —

A commercial bank tries to provide a full service to its big clients. BoA (before merging with ML) was a traditional commercial bank but it also maintained client accounts holding fixed income and equities assets. To provide a more complete service, BoA also provided hedging, risk measurement and other services, making it a partial trading system.

However, I feel this partial trading system was probably not designed to make money for the trader. This partial trading system was more of an extension of the position system or inventory system.

What drv might be curtailed by post-2008 regulations

(A foolhardy prediction by a greenhorn…)

These are the potential casualty but in reality, i don’t know if any of these were curtailed.

IRS – set to grow further, across continents. I don’t think will be curtailed.

Listed derivatives — are all safe and may grow further.

Reasons/justifications for the tighter regulation include —
– systemic failure
– contagion of default, domino effect
– [tv] obstacle to risk assessment
– [v] poor liquidity
– [t] unreliable credit rating

Underlying “defects” in the product set-up —
[t = poor transparency]
[v = opaque pricing, disparate valuations]

high_leverage = low_margin_requirement

forex: typically leverage of 100 ie margin requirement of 1%. (I traded copper and soybean in first half of 1997 using margin
account and leverage.)

You need to put $1K into your margin account to buy $100K of a currency. Your gains and losses are magnified 100 times. High
leverage, high risk.

When market moves against you to reduce your margin to below the required minimum, you get a margin call from the House. If you
don’t top up, the “House” liquidates your position.

“House” is the broker who lends you 99% of the money.

For stocks, typically 10%. With a 10% requirement, you can buy $10K worth of IBM using $1k, borring the rest from your broker.

balance-of-trade and related jargons

* balance of payment INCLUDES current-account (ca). [1] has a formula on that.

* When China sells $1B worth goods/services to US, China receives $1B USD and somehow leave that in the national forex reserve. Is that $1B foreign asset? The $1B is like $1B worth of gold in US owned by China?

— “The Economist” story 2009/01/24 —

* US current account (savings BY US – investment BY US)[2] are in deficit since 1992.

** Q9: what does “invest” mean?** A9: see [3]. In a different context, when economists talk about foreigners investing in US, i think it means foreigners spending USD in US, but not for consumption.

** Experts say US had to borrow[A] from abroad or sell[B] assets to pay for the annual deficits. (Why?)** B would decrease America’s Net Foreign Asset position.** Some articles suggest A is the main source; while other articles suggest B. I think the same transaction can be seen as A and B as 2 sides of a coin. [3] gave some examples of such transactions.** experts say this deficit was used to “finance” some “investment”, though [3] also says US sells assets (B) to “finance” the CA deficit. I guess that “investment” includes investment in biz, R&D, real estate…** experts widely believe China consumer save hugely, and their savings somehow compensate for the low savings of American consumers.

** Q7: how does “foreign SAVERS” and their money play a role?** A7: I guess they buy US properties, gov bonds, and lend to US businesses. Does exporting to US count as “investment” BY foreign savers?** Q8: in the economists eyes, Chinese savers save in USD or CNY?** A8: Neither. I think by “saver” the economists mean “China does not import so much American goods, so they earn more USD than they spend”. The surplus USD must go somewhere. I guess it mostly goes to buying/investing in US assets, which economists call “borrowing-by-US-from-China”

** Q: what does “borrow” mean? who? in what currency? I think economists mean something else

— digestibles —

* A higher savings rate generally corresponds with a trade surplus. China vs US.

* current accoutn includes balance-of-trade (bot) as the biggest component.* * Because exports generate positive net sales, and because the trade balance is typically the largest component of the current account, a current account surplus is usually associated with positive net exports.

* The net foreign asset (NFA) position of a country is the value of the assets that country owns abroad, minus the value of the domestic assets owned by foreigners.

* if a country runs a $700 billion current account deficit, it has to borrow exactly $700 billion from abroad to finance the deficit and therefore, the country’s net foreign asset position falls by $700 billion. Why? Here’s my theory. Suppose US buys $700B worth of Chinese goods/services. US must pay $700B, but US doesn’t earn that much from export to China. Mostly US sells its own assets to China to get that $700B.

* If an annual current account is a surplus of $2T, the country’s net foreign asset (NFA) position increases by that amount $2T.

* US trade deficit — Warren Buffett said “the rest of the world owns $3 trillion more of us than we own of them”, echoing [3]. I think this means over the years, accommulative US trade deficit adds up to $3T and that’s the US asset under foreign ownership.

— References —

[1][2] explained in 2009/01/24 The Economist, but why is this definition so different from balance-of-trade?[3]

financial jargon: buy-side, sell-side

The split between the Buy and Sell sides should be viewed from the perspective of securities exchange services. The investing community must use those services to trade securities. The “Buy Side” are the buyers of those services; the “Sell Side” are the sellers of those services.

Sell side brokerages are registered members of a stock exchange, and required to be market makers in a given security. Buy side firms usually take speculative positions or make relative value trades. Buy side firms participate in a smaller number of overall transactions, and aim to profit from market movements and accruals rather than through risk management and the bid-offer spread.

In Short the entity paying the commission on trade would be a buy side and the one receiving it is a sell side.