The Trade Lifecycle

Drive profit and manage risk with expert guidance on trade processing

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

Trade processing and settlement combined with control of risk has been thrust into the limelight with the recent near collapse of the global financial market. This book provides thorough, practical guidance toward processing the trade, and the risks and rewards it entails.
* Gain deep insight into emerging subject areas
* Understand each step of the trade process
* Examine the individual components of a trade
* Learn how each trade affects everything it touches

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

Foreword from the First Edition xvii
Foreword to the Second Edition xix
Preface xxi
Acknowledgements xxiii
About the Author xxv
PART ONE Products and the Background to Trading
CHAPTER 1 Trading 3
1. 1 How and why do people trade? 3
1. 2 Factors affecting trade 3
1. 3 Market participants 4
1. 4 Means by which trades are transacted 5
1. 5 When is a trade live? 7
1. 6 Consequences of trading 7
1. 7 Trading in the financial services industry 8
1. 8 What do we mean by a trade? 10
1. 9 Who works on the trade and when? 11
1. 10 Summary 12
CHAPTER 2 Risk 13
2. 1 The concept of risk 13
2. 2 Risk is inevitable 13
2. 3 Quantifying risk 14
2. 4 Methods of dealing with risk 15
2. 5 Managing risk 15
2. 6 Problems of unforeseen risk 16
2. 7 Summary 16

CHAPTER 3 Understanding Traded Products - Follow the Money 17
3. 1 Spot trades 18
3. 2 Future (forward) 20
3. 3 Loan 21
3. 4 Deposit 23
3. 5 Swap 23
3. 6 Foreign exchange swap 25
3. 7 Equity spot 26
3. 8 Bond spot 27
3. 9 Option 27
3. 10 Credit default swap 30
3. 11 Summary 31
CHAPTER 4 Asset Classes 33
4. 1 Interest rates 33
4. 2 Foreign exchange (Forex or FX) 40
4. 3 Equity 44
4. 4 Bonds and credit 46
4. 5 Commodities 53
4. 6 Trading across asset classes 58
4. 7 Summary 59
CHAPTER 5 Derivatives, Structures and Hybrids 61
5. 1 Linear 61
5. 2 Nonlinear 62
5. 3 Some option terminology 66
5. 4 Option valuation 67
5. 5 Exotic options 67
5. 6 Structures and hybrids 69
5. 7 Importance of simpler products 70
5. 8 Trade matrix 71
5. 9 Summary 72
CHAPTER 6 Liquidity, Price and Leverage 73
6. 1 Liquidity 73
6. 2 Price 75
6. 3 Leverage 76
6. 4 Summary 79
PART TWO The Trade Lifecycle
CHAPTER 7 Anatomy of a Trade 83
7. 1 The underlying 83
7. 2 General 83
7. 3 Economic 84
7. 4 Sales 84
7. 5 Legal 84
7. 6 Booking 85
7. 7 Counterparty 85
7. 8 Timeline 86
7. 9 Summary 87
CHAPTER 8 Trade Lifecycle 89
8. 1 Pre execution 89
8. 2 Execution and booking 91
8. 3 Confirmation 94
8. 4 Post booking 96
8. 5 Settlement 97
8. 6 What happens overnight 101
8. 7 Changes during lifetime 105
8. 8 Reporting during lifetime 110
8. 9 Exercise 110
8. 10 Maturity 112
8. 11 Example trade 113
8. 12 Summary 115
CHAPTER 9 Cashflows and Asset Holdings 117
9. 1 Holdings 119
9. 2 Value of holding 120
9. 3 Reconciliation 121
9. 4 Consolidated reporting 122
9. 5 Realised and unrealised P&L 122
9. 6 Diversification 122
9. 7 Bank within a bank 123
9. 8 Custody of securities 123
9. 9 Risks 124
9. 10 Summary 124
CHAPTER 10 Risk Management 125
10. 1 Traders 125
10. 2 Risk control 126
10. 3 Trading management 126
10. 4 Senior management 126
10. 5 How do risks arise? 126
10. 6 Different reasons for trades 128
10. 7 Hedging 128
10. 8 What happens when the trader is not around? 128
10. 9 Types of risk 130
10. 10 Trading strategies 132
10. 11 Hedging strategies 133
10. 12 Summary 134
CHAPTER 11 Market Risk Control 135
11. 1 Various methodologies 135
11. 2 Need for risk 139
11. 3 Allocation of risk 139
11. 4 Monitoring of market risk 140
11. 5 Controlling the risk 140
11. 6 Responsibilities of the market risk control department 141
11. 7 Limitations of market risk departments 142
11. 8 Regulatory requirements 143
11. 9 Summary 145
CHAPTER 12 Counterparty Risk Control 147
12. 1 Reasons for non-fulfilment of obligations 147
12. 2 Consequences of counterparty default 148
12. 3 Counterparty risk over time 148
12. 4 How to measure the risk 149
12. 5 Imposing limits 152
12. 6 Who is the counterparty? 153
12. 7 Collateral 153
12. 8 Activities of the counterparty risk control department 154
12. 9 What are the risks involved in analysing credit risk? 157
12. 10 Payment systems 158
12. 11 Summary 160
CHAPTER 13 Accounting 161
13. 1 Balance sheet 161
13. 2 Profit and loss account 164
13. 3 Financial reports for hedge funds and asset managers 168
13. 4 Summary 169
CHAPTER 14 P&L Attribution 171
14. 1 Benefits 171
14. 2 The process 172
14. 3 Example 173
14. 4 Summary 176
CHAPTER 15 People 177
15. 1 Revenue generation 177
15. 2 Activities that support revenue generation 179
15. 3 Control 189
15. 4 Summary 200
CHAPTER 16 Regulation 201
16. 1 Purpose of regulation 201
16. 2 What regulators require 202
16. 3 The problems 204
16. 4 Risk-weighted assets 205
16. 5 Credit valuation adjustment (CVA) 207
16. 6 Summary 213
PART THREE What Really Happens
CHAPTER 17 Insights into the Real World of Capital Markets - Here be Dragons! 217
17. 1 How it used to be 217
17. 2 Clash of cultures 219
17. 3 The equality of money 219
17. 4 The politics of money 220
17. 5 The good 222
17. 6 The bad 222
17. 7 The ugly 223
17. 8 Where are we heading? 223
17. 9 Summary 224
CHAPTER 18 Case Studies 225
18. 1 Case study 1 - Bonds 225
18. 2 Case study 2 - Front office foreign exchange 235
18. 3 Case study 3 - Equity confirmations project 247
18. 4 Summary 252
CHAPTER 19 The IT Divide 253
19. 1 What is the IT divide? 253
19. 2 What problems does it cause? 255
19. 3 IT in the middle 255
19. 4 Improper use of IT 256
19. 5 Organisational blockers 257
19. 6 IT blockers 258
19. 7 How to bridge the gap 259
19. 8 Keeping up with change 260
19. 9 What does the business want from IT? 261
19. 10 What IT wants from the business 263
19. 11 Particular challenges of the financial sector 264
19. 12 Example of a good project 265
19. 13 Example of a bad project 266
19. 14 Summary 266
CHAPTER 20 The Role of the Quantitative Analyst 267
20. 1 What is a quant? 267
20. 2 Where do quants work? 267
20. 3 Tools of the trade 269
20. 4 Place in organisation 270
20. 5 Where should quants sit? 270
20. 6 The boundaries of Quantland 271
20. 7 What does IT think of quants? 273
20. 8 Different types of quants 274
20. 9 Getting the job done 275
20. 10 Summary 275
PART FOUR Behind the Scenes
CHAPTER 21 Developing Processes for New Products (and Improving Processes for Existing Products) 279
21. 1 What is a process? 279
21. 2 The status quo 279
21. 3 How processes evolve 280
21. 4 Inventory of current systems 282
21. 5 Coping with change 284
21. 6 Improving the situation 284
21. 7 Inertia 287
21. 8 Summary 288
CHAPTER 22 New Products 289
22. 1 Origin of new products 289
22. 2 Trial basis 290
22. 3 New trade checklist 292
22. 4 New product evolution 294
22. 5 Risks 294
22. 6 Summary 295
CHAPTER 23 Testing 297
23. 1 What is testing? 297
23. 2 Why is testing important? 298
23. 3 Who does testing? 298
23. 4 When should testing be done? 299
23. 5 What are the types of testing? 300
23. 6 Fault logging 302
23. 7 Risks 304
23. 8 Summary 305
CHAPTER 24 Data 307
24. 1 Common characteristics 307
24. 2 Database 308
24. 3 Data 308
24. 4 Bid/offer spread 310
24. 5 Curves and surfaces 310
24. 6 Market data 313
24. 7 Back testing 317
24. 8 How can data go wrong? 317
24. 9 Typical data sources 320
24. 10 How to cope with corrections to data 321
24. 11 Data integrity 322
24. 12 The business risks of data 324
24. 13 Summary 325
CHAPTER 25 Reports 327
25. 1 What makes a good report? 327
25. 2 Reporting requirements 328
25. 3 When things go wrong 333
25. 4 Redundancy 334
25. 5 Control 335
25. 6 Enhancement 335
25. 7 Security 335
25. 8 Risks 335
25. 9 Summary 336
CHAPTER 26 Calculation 337
26. 1 What does the calculation process actually do? 337
26. 2 The calculation itself 343
26. 3 Sensitivity analysis 347
26. 4 Bootstrapping 348
26. 5 Calculation of dates 349
26. 6 Calibration to market 351
26. 7 Testing 351
26. 8 Integrating a model within a full system 352
26. 9 Risks associated with the valuation process 352
26. 10 Summary 352
PART FIVE Summary of Risks
APPENDIX A Operational Risks 355
APPENDIX B Human Risks 359
APPENDIX C Control Risks 363
APPENDIX D Processing Risks 367
APPENDIX E Organisational Risks 373
Recommended Reading 377
Index 379