liquid products2calibrate model→price exotics #UChicago

Essential domain knowledge, practiced in industry and also endorsed by academia.

1) On a daily basis (or otherwise periodically) use market data to calibrate a model’s parameters. Choose the more liquid instruments …

Note if you don’t re-calibrate frequently, those parameters could become obsolete, just like database index statistics.

2) use the model to price illiquid, exotic products.

Example — In my exam/interview, Professor Yuri pointed out that callable bonds, caps and floors (yes these are options) are the liquid products with liquid market data, and useful for calibration.

some international securities have no cusip/isin but never missing both

ISIN is used in Europe while U.S. uses cusip. A BAML collateral system dev told me some securities in his system have no cusip or no isin, but must have one of them.

I believe some international assets pledged as collateral could be missing one of them.

Japanese gov bond is a common repo asset — cross-currency repo. The borrower needs USD but uses Japanese bond as collateral.

In MS product reference database, I see these identifiers:

  • internal cusip
  • external cusip – used in U.S./Canada
  • cins – CUSIP International Numbering System, for “foreign” securities
  • isin – if you want to trade something inter-nationally
  • sedol
  • bloomberg id
  • Reuters RIC code, RT symbol and RT tick


invest – high risk, high expected return – HY, currencies

In theory, high risk means high (expected, not historical) return. More specifically, if an asset is perceived as more risky, then investors would demand evidence that it would yield higher return.

Simplest example is the risky bond. Assuming zero coupons, both the junk bond and the gov bond has the same maturity value of $100. Junk bond is shown (Evidence!) to be more likely to default, so the current price is lower, leading to higher expected return. That’s the basic idea of risk premium.

A 2nd example is FX carry trade, like long INR/JPY. INR is expected to depreciate so investors demand higher interest.

Long spot in Turkish TRY is another example. High risk high interest.

well-researched ≠ simple #BS, VWAP..

Some people say vwap is easy/simple, when they really mean it’s well-researched. They mean other benchmarks are lesser-known and more sexy. Actually, implementing algos to beat the vwap benchmark is not easy at all.

Some people say standard option pricing model (BS) is trivial. They basically refer to those fancy models like stoch vol etc. I think this is jargon arms race — “who knows the most jargon”. I feel the intricacies of BS model is well-researched but not simple. Is theory of relativity simple?

Some people say vanilla derivatives are simple (cf exotics). well, lots of publications, but many unsolved problems and unanswered questions.

some people say STL is simple. They probably refer to the fancier containers. I feel STL has lot of details we don’t understand.

Some people say java generics (and c#) is simple. They mean compared to c++. But still there are many design tradeoff and implementation details we don’t understand.

mkt-value – basic concept (confusion) cleared

PnL is a cleaner concept than MV. PnL can be -ve/+ve/$0. For MV,

1) In the simple case of bonds and stocks (think of owning a house), if you buy an asset, the MV is always, always positive
1b) a long option position has strictly positive MV
1c) a unit of any fund has strictly positive MV

In these cases, there’s an upfront full payment to the seller, upon execution.

2) MV (position without upfront payment) can have -ve/+ve/$0 MV. (In practice, such a deal is always initiated with MV=$0.)
* futures
* fwd contract on stocks
* FX fwd
* Swaps never require upfront payment

5) FX is tricky
5a) at a money changer, physically buying an asset ccy, using our domestic currency (SGD), is similar to 1). Full payment upfront, so the asset we bought has MV > 0 at all times.
5b) trading a cross (not involving our own ccy SGD) — no upfront. MV can be -ve.

9) Online trading is more tricky. Let’s ban leverage:) Buying an asset ccy using our own currency (ccy2) should be very similar to 5a), but actually the amount of ccy2 doesn’t leave my account. Instead there’s simply a CCY1/CCY2 position recorded in my account. Fundamentally unlike physical trading. In this context, MV of any position can be -ve.

arbitrage definition – any time before maturity

My understanding of the mathematical definition of arbitrage is vague. (I think in real financial world the precision may not be relevant.)

Here is one interesting point – if portfolio A and B have identical terminal value, then any time before maturity, they must always have equal market value, otherwise arbitrage exists. But what if (short) selling or is restricted or trading over a certain period is restricted?

In  real markets, many factors prevent arbitrage

* no bid or ask when you notice a mispricing
* insufficient quantity in the bid/ask. You may wipe it out then wait in vein.
* trading restrictions by authorities,
** short selling disallowed 
* most common factor – wide bid/ask spread, so you can’t really make any money. I think this is the case in most securities including most options.

3 types – pricing curves (family video…

— R@P (range of possibilities) graph, where x-axis = underlier or parameter –
eg: price/yield curve
eg: hockey stick
— family snapshot –
eg: yield curve
eg: vol surface
eg: delta vs underlier spot price
— family video i.e. evolution over time –

high return, high sharpe, high beta

Initially we want high return, or equivalently, high excess return.

naivety 1: we are ignoring the variance of the return.

-} so now we want high sharpe ratio

naivety 2: we didn’t know that all the expected return over the next year will be mostly driven by the market return.

-} so now we use beta to guide our selection.

* We might want a high beta, magnifying market return

** small stocks tend to exhibit high beta

* We might want a low beta, resistant to market up and down

* We might want 0 beta like a time deposit or something uncorrelated with the market

mean reversion – vol^pair^underlier price

I feel implied vol shows more mean reversion than other “assets” (pretending eq vol is an asset class). In fact Wall Street’s biggest eq-vol house has a specific definition for HISTORICAL vol mean-reversion — “daily HISTORICAL vol exceeding weekly HISTORICAL vol over the same sampling period“. In other words “vol of daily Returns exceeding vol of weekly Returns, over the same sampling period”. I think in the previous sentence “vol” means stdev.

This pattern is seen frequently. To trade this pattern, buy var swap, long daily vol and short weekly vol… (but is it h-vol or i-vol??) I am not sure if retail investors could do this though.

In contrast, Stocks, stock indices, commodities and FX can trend up (no long term mean reversion). Fundamental reason? Inflation? Economic growth?

The (simplistic) argument that “a price can’t keep falling” is unconvincing. Both IBM and IBM – 2 yr option can rise and fall.  However, IBM could show a strong trend over 12 months during which it mostly climbs, so a trader betting big on mean reversion may lose massively. The option can have a run, but probably not too long. I feel volatility can’t have long term trends.

A practitioner (Dan) said mean reversion is the basis of pair trading. I guess MR is fairly consistent in the price difference between relative value pairs.

Interest rate? I feel for years IR can trend up, or stay low. I guess the mean reversion strategies won’t apply?

I feel mean reversion works best under free market conditions. The more “manipulated”, the more concentration-of-influence, the less mean reversion at least over the short term. Over long term? No comments.

##what asset classes are important to PB business

Prime brokers provide a wide range of services to hedge funds. What asset classes are important in the PB market? (Note this is subtly different from the question “what asset classes are important to hedge funds”)

#1 Equities
#2 FI

(In Eq and FI, clients get financing.)

#3 futures – no financing
FX is slightly less important

Financing is the most needed “service” and includes
* stock lending
* margin lending
* repo and reverse repo

The 2nd most valuable “service” might be technology
* low-latency direct-market-access (including FX)
* collocation in exchange data center

##most important EM asset classes

According to my own informal survey, “Emerging Market” desk covers

#1 FX
NDF – I think many EM currencies are NDF.

#2 IR and bonds of EM countries – mostly sovereign, also corp

#3a EM IRS — is the largest sub-sector within EM FixedIncomeDerivatives
#3b EM credit derivative — is mostly on sovereign bonds

In EM derivative space, equity derivative is less significant than FX and FI derivatives.

Equities, commodities, … are less significant to EM. I guess there’s no separate EM desk for eq/comm as there are specialized EM FX/FI desks.

3 financing solutions PB offers hedge funds

To a hedge fund (HF), arguably the most valued service by a prime broker (PB) is financing. 2nd is probably execution. Brokers by definition provide access to liquidity, but at what speed? Both #1 and #2 give rise to white hot competitions among brokers, who often invest heavily to offer the most competitive “service” to attract the big hedge funds.

Besides the top 2, Book keeping, back office, accounting etc are essential services too.

I see 3 common financing schemes —

1) margin lending — hedge funds buying on margin is the most common form.
2) stock lending — hard-to-borrow will entail a heftier fee.
3) repo

In all 3 cases, PB earns a fee/interest proportional to the loan duration.

For (3), the PB can provide either repo or reverse-repo service to a hedge fund. Either collateral-out-cash-in or collateral-in-cash-out. I feel the cash-out version (PB-cash->HF) is what hedge funds need most. Overnight to 3 months, rarely longer.

daily PnL of a trading account, basics

Typically, for a given Book, EOD “daily-pnl” is defined as

   closing-MV – open-MV.

Open-MV could be yesterday’s closing-MV. I think yesterday’s closing MV could be negative — if you short-sold IBM before IBM doubled. If you buy some IBM today but  closing price is the same as your trade price, then this new trade has zero impact on PnL. The cash you spent was part of yesterday’s closing total book value.

All the PnL numbers are total PnL i.e. unrealized + realized.

To see how daily-pnl adds up, suppose today is Day 8.

Day 8 daily PnL = Day8 closing MV – Day7 closing MV.
Day 7 daily PnL = Day7 closing MV – Day6 closing MV.

Day 7 pnl could be a loss, but it doesn’t affect Day 8 PnL.

##retail-friendly investment products

listed stocks, futures and options
ETF on equity sectors
ETF on commodities
ETF on bonds
(ETF is like mutual funds, open to small investors.)

FX — through retail dealers — not really “brokers” in the strict sense. There's no public exchange.

Some corporate bonds — similarly through retail dealers
muni bond — more retail-oriented, since the tax advantage targets individual investors.
US treasury bonds

3 types of PWM traders — typical of buy-sides

Clients can trade by themselves through brokerage accounts, but for discretionary accounts, the traders are the investment professionals (IP) and portfolio managers (PM).  PM are the bigger traders.

A PM are product specialist, and manages a portfolio of several SMA (separately managed accounts) invested in a the product she specializes in. In terms of trading, PM are at the top of the food chain in wealth management.See also FX MA in [[Forex revolution]]

PM actually uses specialized trading systems, custom made for them, with a dedicated IT team. They could, if they want to and equipped to, engage in high-frequency trading. As a buy-side trader in a sell-side bank, they enjoy preferential treatment in terms of transaction cost, provided they engage the parent firm’s sell-side trading desk. They can also by pass parent firm and execute on the street — i.e. through a competitor’s sell-side traders. This does happen and they get slapped on the wrist, hard.

They have no relationship with clients.  They don’t handle asset allocation — financial advisers do that.

physical vs cash settlement – option and other drv

CS vs PS is a simple concept but not trivial. As a beginner I often feel “as an option holder i will exercise and get physical settlement” but that's often impractical/unwise. In many markets, the default is cash settlement. Lower transaction cost.

In certain contexts, the holder/buyer prefers physical settlement, for specific reasons. To truly understand options and hedging, we will invariably find yourself in these contexts. Nuances that some beginners may not appreciate.

delta 1, non-linear, optionality

Delta 1 derivatives are intuitive — you can “feel” that a 1-cent drop in underlier causes an (almost exactly[3]) 1-cent drop in the derivative. A common synonym for Delta 1 is ….. Linearity. I think Linear basically means the graph of MV/underlier is straight.

Why is delta one important? Price sensitivity (including greeks, duration, dv01) are the focus on market risk, and delta is the #1 most important sensitivity.

Optionality is the defining feature of non-delta1.

A big bank often puts FX options in a different trading desk than FX forwards/futures and spot — delta 1

A big bank often organizes equity trading along delta 1 (NOT along OTC/listed). As a result,
* all equity options (including index or OTC structured options) and variance swaps are grouped into “volatility” desk. I think convertible bonds too.
* equity futures and basket trading (including ETF) are grouped into equity cash desk. I think equity swaps too.

How about IRS or bonds? I believe they are not delta 1. For interest rate sensitivity in general, DV01 and duration are more useful (probably more comprehensive) than delta. There's not a single underlier variable like a ETF or currency price, but a term structure of Spot yields. Notice I don't mean forecast values of yield but rather spot yield. Let me try to explain a bit.

Outside the fixed income space, a derivative contract uses a Reference variable. The variable has a spot value. On any valuation-date now or in the future, there's just one spot value. In the IR space, the reference entity exists on a yield curve. On any valuation-date, there's an entire spot yield curve (so-called term structure) [2]. A particular position is often sensitive to changes in the reference yield curve [1]. Therefore, an analysis of market-value change due to a change in one interest-rate is inadequate.

[2] actually I feel volatility smile is a “spot” term structure of vol. We construct a smile curve using today's implied vol and get a spot smile. If we use 1/1/2009 implied vol, then we get a spot smile curve as of that date. Using today's information, can we forecast next year's vol smile curve? I don't think we can, but people try anyways.

[1] example – a vanilla bond paying 600bps/year. It's trading t 98.1. What if a there's a parallel yield shift? All upcoming payouts will devalue.  What if there's a yield drop in the far end? Now you see IR sensitivity is not about a single reference variable, but a change to a yield curve.

[3] if delta is almost 1.0, then it's delta 1.

buy-side vs sell-side trader — real diff

buy-side (asset manager incl HF) vs sell-side trader — real diff

Both bet “house money” and keep Positions. See my acid test in What’s the real difference between both? Many friends gave me similar answers — strict hedging (though how strict is questionable — See Barings).

Sell-side trader must delta-hedge her positions. When market moves against her, her bank must be protected by the hedges. Sell-side is part of the “infrastructure” and the financial “services” (buy-side being the service-consumer). Therefore it needs more stability and less risk-taking.

In a volatile environment, a bank is supposed to /survive/ longer than a buy-side. A bank failure triggers deeper /repercussions/ and leads to larger /domino-effects/.

The best-known measure to enforce stability (and reduce risk-taking) on a sell-side trader is a strict policy of hedging. Upper management and regulators want to see VaR numbers and stress test results, periodically.

Effect of hedging should be obvious — risk should be much lower and profit also lower.

Barings didn’t hedge as market makers should. Nick Leeson hated to cut losses when market moved against him. He was acting like a buy-side and his firm failed like a buy-side.

"increase in volatility" can mean 1 of 2 things

An “increase in volatility” actually can mean 2 different things.

@ increase in “historical volatility”, which actually means increase in recent, observed volatility on the Cash market.[1] I feel this is what “increase in volatility” usually means.
@ increase in implied volatility, reflected in higher bid/ask “insurance” premiums on the Options market.

I-vol is forward-looking and refers to predicted future volatility of an underlier (like SPX) over the next 30 days (or 90, or 365 … days). So an increase there reflects people’s anticipation of market volatility.

H-vol is backward-looking and refers to recorded, realized volatility of an underlier (like GBP) over the past few days. When people talk about increase in h-volatility, I believe it’s usually over the Recent past.

[1] if you have an option on futures, then it’s not the Cash market but the futures market, but in this context it’s better to remove this kind of noise and focus on simple concepts.

full time retail traders #my take

(a blog post)

Whenever I hear someone is play the stock market or FX market full time, I wonder if this person has any stable income. Do you know any FTRT having a stable income?

It’s not uncommon to see a “winning strategy” that makes money for months even years, then suddenly suffer a big loss (or losses) that wipes out all the gains.

Some seasoned players (including day traders) accumulate many small gains. They take fewer risks. But I was told they too can suffer a big loss that wipes out all gains. (Personally, in 1997 I was a newbie trader taking small gains every day, but someday market opened with a drastic move, big enough to wipe out 100 small gains, fast enough to leave me no time to react.)

In all these unlucky stories, the annual average income of this FTRT is close to $0, when US median household income is around $55,000. This guy can’t even pay his bills!

These are retail traders, but how about investment banks? Investment banks typically make money from less unpredictable businesses — asset management fees, IPO fees, M&A advisory fees, stock lending, pass-through brokerage (commission based). In bond trading (and single-name stocks?), they tend to monopolize an entire market for an issuer — low chance of losing control, but still can lose control…

Market making is more risky for an i-bank, but should be less risky than our FTRT. The reason why market making is less risky is presumably due to systematic and disciplined hedging.

For an i-bank, the real risky business is prop trading. Apparently big banks suffered big losses just as badly as the FTRT. But I think banks often make big money for many years, then lose, so if you average their PnL, i think it’s positive. (However, some funds declare a negative average PnL, such as the hedge fund started by Citigroup CEO Vikram.)

Compared to investment banks, hedge funds have an /backdoor/ option known as “close down” — All the investors’ money is declared as lost. Effectively, traders use OPM (other people’s money) to gamble. If he’s lucky, he profits; if he bets wrong, other people lose money and he disappears, completely. In contrast, big banks often has to hang in there because it has other businesses to prop up. A family man vs an orphaned bachelor…

In conclusion, FTRT is a dubious concept to me. Big players do employ full time traders because they have more influence on specific markets they choose to play. Still trading full time with one’s own money is highly risky.

preferred stock ^ convertible bond

regular preferred-stock trades in the ….. corp bond desk, along with regular corp bonds.

convertible-bond and convertible-preferred-stock trade in the the ….. equity desk, along with common stocks

Deciding factor is interest-rate sensitive. See P187 [[after the trade is made]]. In general, anything that’s IR-sensitive trades in the fixed income side. For example, convertible preferred stock can pay a fixed amount of dividend now, but can be converted to common stock, so it’s not IR-sensitive.

flow ^ prop trading – according to a young quant

Consider a typical flow trader Fay and a prop trader Peng in an investment bank.

Fay only trades with the registered clients of the bank, typically institutional clients, but also some ultra-rich individuals. Peng seldom trades against the clients of the bank. Peng has an unfair information advantage over those clients. Peng typically trades against other counterparties.

Peng doesn't have to hedge, whereas Fay needs to hedge every trade. Each trade with a client creates a position with a risk. At COB those will contribute to VaR. If it exceeds the VaR limit for Fay, then manager will require Fay to hedge or liquidate. Sometimes Fay's trade creates no position at all.

every trader has a view on at least one primary "variable"

All traders have an view/forecast on some fluctuating “price”. If someone says “I don’t forecast”, she probably follows the majority’s view. Majority is wrong most of the time — See

$ FX traders (buy/sell side) — forecast forex movement. Corporate treasurers are typically see long term. HF and market makers are often short-term. I believe a typical dealer bank worries about even an “overnight” position in any foreign currency.
$ Government bond and IRS traders — forecast IR movement.
$ Crop bond traders — forecast IR and also credit changes, because (my observation) perceived credit quality of issuers affects market value of bond.
$ Stock traders (b/s side) — forecast stock movements. Most mutual funds (most are in equity) add value by forecasting long term, including W. Buffett.
$ Index traders — forecast an entire stock market’s movements.
$ Volatility traders — forecast volatility movements, in addition to underlier movements. Even though vol traders can delta hedge, they still have a view about underlier movement.
$ Commodity traders — forecast commodity price movement. There are probably other factors, but I feel supply/demand is more important in this domain than other domains, because supply is limited and demand is steady. Both are less subject to manipulation.

sell at exactly $55.5, !!higher !!lower

Sometimes you want to sell at exactly $55.5, not higher not lower.

If your FA/broker sells lower than you asked, then you are obviously unhappy.

If you get sold higher than you planned, you may regret too, because you bought at $57! You wish for the price to recover. You have a max loss tolerance (and a stop-loss order) so you want to wait till $55.5 and then give up. In this case you gave up too early. If you repeat this frequently, you are a chicken.

Now turn to buying….
Q: As a buyer, when would you regret buying lower than your target of $55.5?

A: say you tell broker to buy at $55.5 if market condition remains calm. Earthquake! Broker bought at $27, half your target price. You fire Broker because he didn't know how to judge “market condition”.

interpret a buy trade — non-trivial

When someone BUYS a block BUY, she may want price to RISE, so that she can sell sooner. In this very realistic scenario, if she sees part of her big order filled at 10% below the original “arrival price”, she would be devastated. As a margin trader, she may collapse. Her broker would force a big sell at the market price, sinking the entire market further.

For a high-frequency buyer, rise is better AFTER her buy executes. Fall is unfortunate, but now he could buy more.

Rule — Most buyers (big or small, short or long term) wish that their buy was at some kind of turning point.

When someone BUYS a block BUY, she may want price to NOT RISE, so as to minimize impact. She may want to slowly and discreetly execute a big trade.

When someone buys, price generally tend to rise — think of the order book. However, she may want price to FALL, so she can buy more at a better price. This would be the scenario of a agency trader executing a large buy order at the “arrival price”. Client might be Warren Buffett, who wants to buy and hold 900m shares. In this case buyer wants price to FALL during order execution.

Rule — In conclusion, a buyer may want a price drop or price rise.

Rule — a buyer may be either bullish or bearish.

A bear may have sold first, and is now buying back.

the more information u have, the less randomness u see


In a given market (say some commodity – favorite example), big players don’t see randomness. They see price actions as a result of a few big players’ positions and decisions. Small players (I was once trading copper, soybeans, wheat..) see randomness.

When I was a boy I enjoyed pouring various liquids into the “home” of ants — random events to the insects. I guess some “smart ants” could record rainfall and build statistical models based on this kind of observed randomness. It gives me nightmares of building a nice-looking palace on quicksand.

Here’s a gross simplification — When we don’t have the information about what move the market, we build some theory of randomness to explain it.

Another analogy – a falling leaf in a wind lands in random spots around the tree. We could build a theory of randomness, but what if the wind come from 10 powerful electric fans?

In hindsight people see nothing random in any market. This is remotely related to the 3rd part of the black swan theory. In hindsight we often know exactly who (possibly a large herd of investors) did what to create a surprise (possibly a black swan) and cause a big loss to a lot of uninformed investors. In such a scenario, the math models are not extremely useful.

“Herd” reacts to wolf howls and shepherd.

biggest market mover: seldom a large number of small players

(need a better title…) When people say things like

“the market has discounted …”, or
“the market has priced in …”, or
“the market rejected …”, or…

they seem to suggest a large number of roughly equal players collectively feel a certain way and the resulting market price[1] reflects their collective reactions, interpretations, outlook and sentiment. (Some may argue that the result reflects 2 camps — bears vs bulls.) But I feel it’s naive and simplistic. Often market price is (legitimately) influenced by a small number of power players.

Case in point – The largest markets — currency, interest rates, sovereign debt — are supposed to be the hardest to manipulate due to sheer sizes, but are actually influenced by a few individuals in big hedge funds and governments, people like Soros.

People tell me investment banks are not prop traders and legally restrained from hedge-fund tactics, so these people feel i-banks actually have less influence on these markets. I am skeptical. Big banks operate at the center of “information vortex”, an enviable position of influence. They WILL exploit it.

Speaking of forex, how about the non-speculative “hedgers” — like big multinational corporations who transact in multiple countries? I feel they aren’t in the business of moving billions of dollars everyday to manipulate market, (though they move billions annually). I might be uninformed.

In a typical forex market, a 100mio [3] order is likely to cause market impact as it sweeps up a lot of limit orders on the other side. I feel many players have the credit limit to send 100mio orders. If a forex rate gains some pips over 24 hours, it might be due to such orders. However, these effects are still small and temporary — A forex rate often shifts 20% over 12 months.

[3] this figure is mentioned by some FX veterans in 2011. It’s documented since the 90’s that a single large trade by a corporation CAN indeed move the best bid/ask, at least in the short term.

Another factor to market movement is information asymmetry. Information is key to investor behavior. Big players gets more information. They radiate and manipulate information while small players largely receive (then filter) information. Among the consequences, a large number of small players can be influenced to buy/sell a security and therefore move a market.

Let’s ignore herd instinct[2]. In any market with a standard order book, the mid-price is the most prominent but its design gives a lot of influence to a single player with deep pockets. All the smaller players can be sidelined quite easily.

[2] (which is the more important reason big players can influence a market).

Case in point – Commodities markets are influenced by big suppliers/wholesalers, and to a lesser extent big investment banks.

Case in point — Corporate securities – bonds, stocks, CDS – are easier to influence and susceptible to manipulation.

[1] Note the one numeric indicator referred to is …. the oscillating mid-price. In these statements, “The market” actually has a more complete meaning including
– depth of market — sizes of “next best” quotes
– all the recent trades in that security
…but it’s ok to simplify everything to a single number.

prop trading ≠ principal investment

An investment bank does both proprietary trading and principal investment, using house money (bank's own capital), but what's the difference between the 2?

PT is trading – short cycle, fairly frequent.

PI is investment — supposed to be long term strategic investment. Quite often, security is not publicly traded, in which case you can't quickly sell out.

I believe PT is now being moved out of investment banks, but no PI. An i-bank's PT desk can “bet against” its clients. PI is less harmful/damaging, at least on the surface.

Example of PI — Goldman's long term strategic invesment in ICBC.

curve-based pricing – briefly

Most non-trivial pricing systems use some curves.

* term structures – usually means time-based curves
* swap curve – closely related to yield curve
* yield curve
* discount curve
* fwd curve
* dividend curve
* vol surface
* credit default curve (hazard rate)

Who don’t use curves? Some pricing systems simply “adopt” bid/ask from the market with minimal validation. Perhaps good enough for mark-to-market, but not pre-trade. Simplistic (almost naive) pre-trade pricing algo gives up our independent thinking and makes our trading engine a blind slave.

A lot of the best bid/ask aren’t _consistent_.
– consistent with historical data
– consistent with other parts of a curve. Outliers.

Therefore, chief challenges in curve-based pricing include
– selecting the most suitable analytical form – polynomial, exponential, piece-wise linear(?) …
– outliers,
– curve-fitting,
– smoothness calculation,
– fitting cost calculation — measures deviation from original points.

trade commission exists in any security market

Many authorities claim that “unlike stock market, this … market has no trade commission”. Those authorities often say you just pay for the bid/ask spread and the dealer just earns that spread.

In reality, any transaction (even if just buyer/seller without middleman) can involve commission or transaction fee. The bigger player or Whoever with more power can more or less “arbitrarily” impose a transaction fee to cover her expenses, whatever they are.

Examples of "Structured_Products"

I believe “structured” and “exotic” mean the same — tailor-made or customized. (However, non-listed products could be quite common. There are so many common OTC instruments but I will give just a few — CDS, IRS, FRA, FX swaps, currency swaps, muni bonds, corp bonds… These aren’t tailor-made.)

* variance swaps — some are flow products, but I guess others are structured
* binary options
* Exotic FI notes
* Snowballs
* Callable range accruals
* Dual Range Accruals
* TaRNs
* STAR Index Linked Notes
* Quanto’s Steepeners
* Interest Rate Hybrids
* Spread Options
* Reverse Floaters and Callable Capped Floaters
* And other popular trade types
* structures linked to a wide range of assets including:
**Interest Rates

foundation — spot rate (&&discount factor)

This post is based on zeros. See also post on spot, FRA … based on Libor.

Assumption: semi-annual compounding. Most US bonds follow it.

Suppose spot rate == 500 bps/year for a 2 year term (ie 4 x 6 months), it means on the market, people are willing to close deals like “Take my $1M today. Repay in 2 years (1.025*1.025*1.025*1.025)*$1M = $1,103,800”, which is 10.38% [2] more than the loan amount.

If i know people agree today to borrow $1M and repay in 2 years $1.1038M, then I can derive the semi-annual compound rate to be 2.5%/semi, or 5%pa but compounded-semiannually. In fact, an instrument exists that pays the $1.1038M in a 2-year term. This instrument is known as a zero-coupon bond. Discount factor for this 2-year term is 1/(1.025 * 1.025 * 1.025 * 1.025). Having $1,103.800 in 2 years is as desirable as having $1M today.

[2] Note spot rate is not 10.38%. Spot rate is a reflection of market sentiments and is directly reflected in the price of zero-coupon STRIPS.

— spot rate (SR) and (DF) discount factor —
For a given future date, spot rate can be derived from discount factor. Since discount factor is a market rate, spot rate is a reflection of market sentiment too. A measure of market sentiments on the time value of money.

In low inflaciton/interest years, spot rate is low, i.e. discount is “light”. Personally, i feel the discount factor concept is simpler than spot rate.

Starting from market prices, it’s simper to derive discount factors than spot rates. Both discount factor and spot rate are functions of length or maturity. Forward rate is more complicated. I think mathematically you can derive SR and DF from each other. SR fully describes time value of money (over various terms) on a given day on the market.

eq cash agency trade volume #systems to support it

A friend in the exchange connectivity team of a big investment bank told me they get half a million orders daily. On average, 2 partial fills per order, so about a million “matches” at the exchanges.

GS TPS feed has about 1 mio eq trades/day.

However, a UBS claims to process 90 million client orders daily (another mgr said 500 mio, and a hiring mgr said 100 mio transactions/day), mostly eq cash trades. Around 5000 clients.

300,000 events/sec (confirmed) message throughput. Latency is either 50us or 50ms per order.

For each client, all messages (cancels, amends, executions…) are processed on a single thread. Otherwise state maintenance is tricky. Multiple clients could, at least in theory, share a single thread.

(ADP) agency^prop traders^dealer^broker^

See also

— AAAAAgency trader =~= broker (=?= flow trader) —
* ideally holds no position (therefore takes no risks), unlike other models.
* earns commission ie “transaction-fee” as a pre-defined percentage of the transaction amount.
** The stock exchange also earns a transaction fee on each trade. Same model
** inter-dealer broker too, like e-speed, taking no risk
* has a seat on the exchange. Sponsors client’s trades but depends on clients to fulfill obligations. For a sell, client must quickly provide the stock to the broker, so broker can transfer it to the counter party. If client disappears, then broker is short and must buy on the open market for cover.
* eg: My OCBS broker was such an example, though she is subject to client risk

— DDDDDealership —
* (defining feature) Keeps inventory.
* eg MTS traders
* like a car dealership.
* takes on the opposite side to the client
* Often buys for client’s request. Could also buy without client request but it ties up massive capital.
* for our long positions, we maintain firm offers.
* Earns a bid/offer spread. Commission? Part of the spread.
* traders – Mostly PnL-based compensation
* Seldom shorts, and shorts only liquid securities.
* eg: I believe a bond trading desk is usually a dealership, just like a car dealership. When a client wants a bond we don’t have, we buy them on the market under house’s account, then sell to the client — virtual trade.

— PPPPPPProp trader —
* no “client” to serve, unlike other models.
* buys and holds for any length of time, but might tie up too much capital
* could accept client’s money as in a mutual fund
* eg: Hedge fund is best example

~~ flow^prop indistinguishable
client A wants to sell ABC, you bid $50, trade is done. you decide to keep it on the book for a bit as you think it’s got potential. you exit at $60 eventually. is it prop or flow? flow brought you the business, and you may not have paid as much attention to ABC company until the client brought it up. but you took a prop view…

(ADP)#1 acid test for broker/dealer/prop/flow…traders

When people mention agency-traders, sales-traders, position-traders, flow-trader, prop-traders, online-brokers, market-makers, dealers … half of your confusion can be cleared by A1 below.  A2 can clear half of the remaining doubts.

Q1: NEVER keep positions, therefore never a counter-party?
A1: NEVER for sales-traders, sales-brokers, salespersons, inter-dealer-brokers, Bud Fox…

Q1b: does this role take on market risk?
Q1c (Yes or no please.) does his own portfolio (if any) change due to this trade?
– If NO, then it’s a maTCH-maker, a pure-play broker such as an inter-dealer broker like espeed, or interbank broker like EBS.
– If YES, then it can be a dealer such as a maRKET-maker, or a prop trader such as a fund manager, or an agency trader, a flow trader, or a lending broker.

Q2: ALWAYS client-driven?
yes for agency traders, sales traders …
no for prop traders.

Related to Q1 —
Q8: does he keep an inventory (kind of low-risk long positions)?

Another interesting question but less significant.
Q10: Does this role earn any fee?
Q10a: client-visible fees such as Exchange fee?
Q10b: client-invisible fees such as Salesmen commission?
Q10c: does he make money by the bid/ask spread or earns a commission?

(ADP) Barings – agency trading outweights prop trading

Most futures dealers (Barings bank etc) don’t allow their traders to initiate a trade without client request. Basically forbids prop trading. Prop trading (using Barings’ own money) was too dangerous and destroyed Barings.

Barings (or any other broker, dealer) is an exchange member and sponsors client’s trades. All non-members must engage a member to trade on any exchange including NYSE.

Futures market is mostly driven by client-request -> sponsor.

Muni market is similar — client-request -> dealer.

In both cases, the bank takes positions and risks. Now I feel some stock brokers do the same.

SIMEX disallows members to finance client’s margin account.

(ADP) "broker" means..@@

The word “broker” is an overloaded term. It can take on exactly One of many very different meanings. 2 of them are most common

A) in prime brokerage, the broker sponsors all the trades done by the Hedge Fund. Broker is the counterparty to every trade.
** Broker is like a “parent” of the naughty kid. Kid can do any stupid thing, and the parent is held responsible.
** Similarly, my stock broker (OC), lending money to me and taking risks

B) a commission-based salesman, who takes no position no risk
** eg: interdealer broker like espeed, lending no money, never a counterparty to a trade, and taking no risk no position

Other meanings —
* in FX, a “broker” can mean anyone you use to access the market.
** (Contrary to the strict meaning of “broker”) Could well be a market maker i.e. a dealer

* pit traders who aren’t locals (locals are typically market makers)

* Bud Fox in the Wall Street movie, who takes no position or risk.

(This paragraph was written when we basically ignored (A) above.) I believe a pure-play broker usually takes zero or small risk, and zero or brief position. As soon as a broker buys and holds [1] a security, she acts more like a dealer.

[1] or short sells

(ADP) sales ^ trading

~~ sales ^ trading
basic question cutting through all the categories in the big ADP post —
Q: is compensation PnL-based [trading] or [sales] transaction fee?

GS and other trading houses have 2 big departments – sales vs trading.
– “Sales” means brokers, bringing in customer orders. They probably hand the order to agency traders
– “trading” includes dealership, prop trading, and perhaps agency trading.

GS makes tons of money in 1) agency trading esp. block trades, 2) dealership and 3) prop trading.

(ADP) mkt-makers

“Market-making” is an over-generalized and misused term. Many so-called market-makers publish “indicative” or fake quotes (instead of uncanceled limit orders), or one-way quotes, or wide quotes.

By strict definition, market maker of a security/instrument must maintain firm and tight bid/ask. They take market-risk to create liquidity, so they get compensated somehow. Market making is a job, a responsibility, and a business, just like policing, match making, ..

Say a seller client is asking $300 for IBM, and a buyer client is bidding $100. No deal. A partial sign of poor liquidity (see Market maker now publishes 2 quotes — asking $200.05 and $199.95 bid. Now the buyer [3] lifts the offer $200.05 + some fees. Now market maker gives in a bit to bid $199.99, as he tries to cover his short position. After some time the seller jumps and sells at that price. Market maker makes a small profit to compensate for the m-risk he assumes.

[3] Note as market takers buyers always get the worse of the 2 quotes i.e. the higher one.

There’s a difference between nasdaq market maker vs a NYSE specialist. See

After you understand the basic biz models (, you will realize

* Market-maker is usually a dealer or a prop trader, PnL-based compensation
* when you make a market, you put house/own money at risk — exactly like prop trading
* Very loosely, a broker role is the “opposite” of market-maker. Most visible in the CBOT trading pit. Brokers take position/risk[1] very very briefly, and trade only upon client orders; market-makers always take positions and _maintain_ bid/offer.
* a dealer often plays market-maker, esp. prevalent in the Treasury/corp/muni market, and IRS/CDS markets, and FX options market and many OTC markets
* MM on a stock exchange? dealers and prop traders. If a broker plays MM, she becomes a prop trader and risks her own money.
* eg: Those locals in the pit could give one-way quotes, so not true market makers

[1] and only when clients default

reserve management in a bond dealer desk

A “reserve” is placed by a retail trading system and “owned” by a subsystem therein – called reserve manager. This retail system is a “client” of the trading desk built atop the desk’s inventory.

One of the most important servers (runs as a daemon) of the desk — the Offer mgr — receive a reserve request, and actually “moves” a portion (say 20 bonds) to the reserve mgr and says good-night to those 20 bonds. (They may come back though.)
– If the reserve expires untouched, the 20 bonds “move” back from reserve mgr to offer mgr.
– If part (say 15 bonds) of the reserve goes unused and expires, they too “move” back from reserve mgr to offer mgr.
– If the entire reserve quantity is bought by the requesting client, then reserve mgr and offer mgr both say farewell to the 20 bonds.

In the partial (15 bonds) case, the retail client actually buys part (5 bonds) of the reserve quantity. We say farewell to the 5 bonds, book the trade and leave the remaining (15 bonds) with the reserve mgr until expiration.

necessity: some trading module imt others

“non-optional + non-trivial” is the key.

Context – trading systems.

I feel trade booking/capture is among the “least optional”. Similarly, settlement, cash mgmt, GL, position database, daily pnl (incl. unrealized). Even the smallest trading shops have these automated. Reasons – automation, reliability, volume. Relational Database is necessary and proven. These are Generally the very first wave of boring, low-pay IT systems. In contrast a lot of new, hot technologies look experimental, evolving and not undoubtedly necessary or proven —

* Sophisticated risk engine is less proven. I don’t know if traders really trust it.
* Pre-trade analysis is less proven.
* huge Market data often feed into research department, risk/analysis systems. I feel some small portion of market data is necessary.
* models
* Algo trading, often based on market data and models
* object DB, dist cache, cloud aren’t always needed
* MOM? i guess many trading systems don’t use MOM but very rare.

equity-linked notes, briefly

From the dealer/issuer’s stand point, ELN is a debt issue. ELN is a note i.e. a short-term bond, therefore a debt to be repaid. The issuer Borrows money from the Investor and will pay it back upon maturity.

So far, this sounds like a regular bond. What’s the difference? Well, ELN is a debt issue + an equity option written by the issuer.

I believe an ELN contract typically stipulates a reference stock index. If the index gains 50% and participation rate is 80%, then investor receives $1.40 for each dollar invested — an example from This is a contractual agreement. Issuer doesn’t invest in the index.

However, if the index doesn’t gain, the investor is protected 100% but receives no interest — like a zero-coupon bond. Therefore the investor effectively buys a zero-coupon bond + an option from the issuer.

Q: How does the issuer profit?
– if index falls, issuer borrows money interest-free
– if index gains, issuer could invest the money in higher-return securities and only pass a small portion of the gain. Even if issuer invests in the reference index directly, only part of the gain need to be returned to investor.

Q: How can a retail investor replicate an ELN of $10,000 + 80% participation? I guess you can buy a discount note + an index option.
+ buy a note with face value $10,000 matching the target maturity. Current price is by definition a discount below $10,000
+ suppose index is $1000 now, just buy 8 ATM call options with the same maturity. Premium might be $400. If index falls they expire worthless but we still get the $10,000 from the note.

daily margin call – simplest futures illustration

Simplest and best-known margin calc is in commodity futures, say a Dec oil contract. Let me use it to describe daily margin calc in my own language.

Clearing house computes and issues daily margin calls. Therefore the formula/algo is crafted from the clearing house’s standpoint. Goal is to protect the clearing house from
1) any “reasonable volatility” i.e. a daily price swing smaller than the extreme 0.05% cases. (More extreme cases would show Larger swings.)
Here, let’s assume house estimates 1% maximum daily move.
2) any reasonable/unreasonable member default.

relevant — EOD best bid/ask
irrelevant — Current spot price — irrelevant.
irrelevant — Last transaction price for the same Fut contract — irrelevant.

Suppose current mid-day fut price = {89.99/90.01} ie {best bid/offer}

Suppose I BUY a contract mid-day at the market i.e. $90.01. Clearing house locks up an amount $x as collateral in my margin account to protect house against my default. If I default, on delivery date house still [1] need to BUY from the contract seller @ $90.01 the agreement/transaction price, but how does the house get the cash to BUY? To answer that, let me first Introducing the basic long margin call formula

  EOD-liquidation-value [my long position]  – 1% + x = $90.01 // Soon We will solve the margin requirement $x of a long, using agreement price and best BID at EndOfDay.

Here the clearing house is assuming market moves at most 1% against me by end of Day2. So if I declare bankruptcy on Day2, house liquidates my long position at most 1% below Day1’s EOD mv.

We will denote “current liquidation value of some position” as mv[that pos]

Now, mv [my long pos] is simply the best SELLING price of that asset (the oil contract) when house must liquidate my position. Think hard — That’s actually the end-of-day best BID. That’s $89.99 in our case, assuming no market move.

  x = $90.01 – $89.99 * 99%, roughly $0.02, which translates to $0.02k = $20. Here we assume each full contract is $90k when price = $90

— Now suppose market collapses drastically and moves against me to ($88/$88.02)

mv [my long position] – 1% + x = $90.01 // $90.01 is the me-counterparty agreement price

x = $90.01 – $88 * 99%, roughly $2.01k

A 2.2% Fut price change (89.99 to 88) causes a large margin call. I would say the margin call roughly matches the physical contract valuation drop from $89.990K to $88K

[1] so my default doesn’t cause a chain reaction taking down the seller.

ledger vs trade booking (aka product processor)

In any trading desk, there’s a product processor specifically for a subset of asset classes. For example, OTC eq options probably uses a different product processor than listed eq options. Arguably the Most essential function of Product processor is trade booking. I-ticket is an example.

Ledger is the authoritative books-and-records for a subset of trading accounts. It’s not current — There’s end-of-day recon between trade booking and ledger. Before the recon, ledger could be out of date, so the trade booking has the most updated positions.

There’s a ledger for treasuries, for eq (TMS), for muni (TMS) etc. They all roll up to GL.

In GS private wealth, the heart of the system is the ledger not for trading accounts but for client accounts – client sub-ledger. To ensure it gets updated correctly, there’s nightly recon with product processors (ie trade booking). There’s a dedicated operations team to resolve all breaks within about 7 hours.

firm ledger vs client ledger

A broker-dealer’s ledgers roll up to GL. I did GL posting for the GS private wealth business. I post profits (and losses) earned in PWM’s account and IBD’s account and FICC’s account etc, but these accounts belong to the broker/dealer , so they logically roll up into a GL hierarchy.


Client sub-ledger doesn’t roll up to GL. Assets in those sub ledger accounts  belong to clients not the firm. If there’s any roll-up, it’s among the multiple accounts of a single client.

various meanings of "forward"

Note any time people say “forward”, it’s relative to “spot” or current. Background – There’s always some _fluctuating_, measurable variable. Think of it as temperature. It has an observable current level, and people try to estimate the level in x months, and people trade on that estimate.

forward price of an underlying security — is the simplest. Relevant in the Black-Scholes

“forward price” in Treasury — is probably a misnomer IMO. P132 [[complete guide]] clarifies the 2 meanings of “forward-price”

forward rate — see blog on FRA. It is like a CD rate for a 3 month term starting x months from today.

forward contract — see blog. It’s a contract to delivery some copper, or currency, or a treasury.

collateral in various trading systems

I know a few distinct systems relying on collateral (re)valuation.

– margin trading. The assets bought is held under the broker's name. Used as collateral. Broker has the right to liquidate the position if a margin call fails.
** forwards
** OTC options
– IRS ?
– repo
– regular car loan
– regular mortgage
– many corporate loans

In all cases, collateral needs to be re-valued periodically – mark-to-market.

I feel custodian bank doesn't hold your assets as collateral. They have no legal right to liquidate your assets.

wealth management is !! technology intensive

(Blog post)


In terms of technology sophistication and criticality, trading is way ahead of investment banking, portfolio management, wealth management, private banking, and traditional banking sectors such as loans, cards and trade financing.


(Incidentally, I think profit margin follows a similar pattern. Trading, investment banking and fund management including private equity have higher margins. Note these are entirely institutional. Nothing on the retail side is comparable margin-wise, but high net worth wealth management still offers higher margin than other retail businesses.)


Back to technology, investment banking (M&A, fund raising…) and fund management have far lower trading volumes (unless a hedge fund engages in HFT). They generate big profits not through technology but other means. Hiring managers in IB and asset management undoubtedly claim technology is critical but it’s not as critical as in trading.


One of the smartest colleagues in GS wealth management IT once asked in a town hall whether technology is a competitive advantage in the private wealth business. He was asking the business representatives on the stage. I remember answer was vague. Business said the most important feature they are still praying for is quick retrieval of any client’s full portfolio and its current market value on demand. Note there are (up to) millions of clients in UBS and each client could have hundreds (if not thousands) of positions held in their private accounts, and these positions could change any time as clients trade.


Nevertheless, these challenges pale against the technical challenges in high-volume electronic trading. Within the trading space, FI and commodities are behind eq and FX, except interest rate futures. Equity has the reputation of leading-edge technology.

leverage entails margin re-calculation, collateral re-valuation

Leverage is buzzword. It's behind the 2008 GFC, which leads to de-leverage. It's behind futures, options, CDS

Leverage means buy/sell on margin. Margin needs to be revalued daily. Margin calls are used to protect the margin-providers i.e. lender or clearing house.

Margin calculation depends on the same valuation methodologies as pricing and PnL. Most cash products are easy to value. Many derivatives require complex valuation.

Q: What specific “modules” of math are involved?
A: margin ratio for long and short
A: collateral credit risk if it's a corporate bond.
A: valuation formulas

financial jargon: forward rate

Forward rate values are derived (from bond prices over different maturities). Forward rates are a useful way to uncover the expected interest rate movements in, say, 5 months. If you believe interest rate will exceed that [1], then invest in short-term bonds so you can reinvest in 6 months at the higher rate you foresee. The above was based on a FI math text book, but the spot rate (underlying instrument of FRA) is also quoted in Libor as eurodollar deposit rates.

[1] “that” being the market’s expectation. Market prices of STRIPS (of various maturities) collectively reveal something [2] to the trained professional — investor community’s expected interest rate movement over the next x years. In other words, forward rates. Therefore, forward rates (over various periods) is yet another measure of sentiment, yet another characterization of the current market.

[2] Suppose the revelation is a series of 6-month forward rates, 6 months forward, 1 year forward, 1.5 year forward, 2 years forward… Now, a 5-year c-strips is an instrument locking in all those forward rates…

product control job function, briefly

PC is all about validating daily pnl. Traders own their trading accounts, so they decide on the mark-to-market, but validation needed by a third party – comes PC.

Fincon is a different job function — posting pnl to GL.

3 common levels of securities —

Level 1: system generated valuation. Includes exchanged traded securities.
Level 2: model-validated valuation. Covers Most OTC derivatives.
Level 3: no suitable model. Covers CDS

I feel realized PnL is straightforward. Unrealized PnL needs mark-to-market. In 1997 I invested into commodities futures. Every day, I saw unrealized profit, then it turned to unrealized loss. That was Level 1.

accrued interest – financing cost == interest gain

I had difficulty understanding accrued interest until I realized —


If I hold a bond for half a coupon period, then I’m entitled to half the coupon interest. However, to “finance” the purchase, I borrow fund from a bank at some interest rate.


In a trading desk, it’s common to consider the (accrued interest – financing cost) as a net interest, which is a profit to trader.

how citi stays on top in munis

Other underwriters do try but can’t catch up with the leader.

–IPO market
When an underwriter gets a deal, they travel around the country to collect bids. Citi muni has a good distribution network (remember Global Transaction Service?) reaching out to hedge funds, pension funds, mutual funds etc.

citi often joins a syndicate to share the risk and share the profit. I guess the gorilla often influence the terms and enjoys the best margin.

muni issuers always call citi first – the market leader.

— secondary market
any muni salesforce need a lot of small “local” licenses to sell muni bonds in each local market. I guess it’s due to the tax implications. It takes a lot of effort to get those local licenses.

margin account, briefly

By definition, an account holds securities. A margin account can hold long securities, short securities, long cash and short cash.

When you short 500 of IBM, sales proceeds go into margin account to cover the short position, since you are expected to buy back the stock.

The *equity* of the margin account is simply what is left when the debit balance is paid in full or the shorted stocks have been bought back and returned to the lender. Equity doesn’t mean stock. It probably means the total value of stocks and cash. For long accounts, Equity = long MV – DR ie debit balance.

The amount of margin (available to investor, calculated by House every day) will depend on the price of the securities. If margin is used to buy securities, then the amount of margin increases with price, but if the margin is used to short securities, then the amount of margin is inversely related to the price of the shorted securities, and vice versa.

financial jargon: debit balance is a loan amount

When buying on margin, investors borrow funds (the amount is the DB) from their broker and then combine those funds with their own to purchase a greater number of shares than they would have been able to purchase with their own funds.

The debit amount (interest charge + any fee) recorded by the brokerage in an investor’s account represents the cash cost of the transaction to the investor. Also see “Credit Balance”.

How long to hold a position – eq der sell-side trader

In facilitation (match-maker??), a bank trader doesn’t need to hold position. Client makes the request. Trader finds a quote from the market and marks up, then makes a 2-leg trade. Same as TMC virtual trades. Not sure how widespread this practice is. For listed instrument, client probably gets the exact listed price, but pays a commission to the broker. In FX spot trading, some say there’s no commission — brokers mark up the upstream bid/ask and profit from the wider spread. However, I believe many FX ECN’s do charge commission. Their business model is price transparency, never-hold-position, pure MATCH-maker, never MARKET-maker.

If the deal is tailor made for a client, then the trader may have to be the counter party and therefore hold the position for the full life time of the deal.

Prop traders? no “client request”. Can hold very long.

what is an ACCOUNT

We hear the term “account” in such diverse contexts, I sometimes lose sight of the 2 essential things about an account.

An account exists for the purpose to hold assets[1] under an owner[2].
Analogy: a drawer with a label showing the owner.

[2] In a complex multilateral transaction, the participants are represented and identified by accounts. Accounts are avatars.
[1] stuff held in an account could be securities, assets. On websites, an account can hold history, personalization data, requests or anything — an account is an avatar of a user.

GS hosts many types of client accounts, but GS has just one account with NYSE.

Trading account — each P/L entity needs a trading account.

financial jargon: principal-investing

… something unclear.

There are Public-Principal-Investments and Private-Principal-Investments. If a bank makes a PI into security A, the bank invests its own money into such a position.

make pricipal investments directly” means? with “our own” money instead of other people’s money such as clients’ $?

principal-investing is closely related to co-investing. For a investment bank, clients seek not only advice, but co-investment.

error accounts

• Just like a client account, an EA (error account) can hold a security, like 100 shares of IBM.
• Just like a client account, it can hold cash.
• Just like a client account, it can hold cash in a short position like negative $1M.
• Just like a client account, it can hold a short position in a security, like -100 shares of IBM.

An error account holds any of these positions briefly. We try to reduce these positions to 0 ASAP, usually within the same day. We flatten the positions and flush the error account.

• If the EA holds cash, we *journal* it out to a firm account
• If the EA is short in cash, we journal cash in, perhaps from a firm account
• If the EA holds a security, we sell it (not sure if we journal that out)
• If the EA has a short position in IBM, we buy it to cover the short position.

financial jargon: short

shorting is essential to hedging, and essential to risk analytics

“shorts” means short positions or short trades, and can also mean the holders of short positions

“the short” = the seller, and “the long” = the buyer in a trade.

You COVER your SHORT POSITION by buying.

You “go short” at a price and cover at another (hopefully lower) price.

In other words, you have a “short sale” at $x, covered at $y.

stock lending

There’s probably no “electronic market” to publish offerings. I’m a GS trader with good friends in MS and UBS, I will get weekly(!) inventory feeds from them, perhaps an ftp, a spreadsheet etc. Then we agree on the terms [1] over phone. No automatic agreement! After agreement, borrower can request to borrow over web/ftp.. and delivery can be automated.

At its core, SL system keeps inventory, stocks lent out, stocks borrowed.

[1] Unlike repo, market price isn’t relevant. If I borrow 100 IBM, i agree to return it x days later. No buying! Repo involves buying ie (temporary) change of ownership.

Above is for stocks. For futures and FI instruments, there are different systems.