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The Trade Lifecycle: Behind the Scenes of the Trading Process

The Trade Lifecycle: Behind the Scenes of the Trading Process

Robert P. Baker

ISBN: 978-0-470-97160-4

May 2010

320 pages

Select type: E-Book



The lifecycle of a trade is the fundamental activity of investment banks, hedge funds, pension funds and many other financial companies. There is no better way to understand the working s of a financial institution than to follow the progress of a trade through all of its various stages and all the activities performed upon it.

The Trade Lifecycle: Behind the Scenes of the Trading Process is a guide to the trade lifecycle and it inherent risks and weaknesses. The book dissects a trade into its component parts, tracking it from pre-conception to maturity, and examines how the trade affects each business function of a financial institution. As well as illustrating each part of the trade process it highlights the legal, operational, liquidity, credit and market risks to which the trade is exposed. Readers will benefit from a full understanding of all parts of the trade process, including derivative and credit derivative trades and will also see, with examples where appropriate, how the mismanagement of these risks led to the recent financial crisis.

The book is divided in to 4 parts. Part 1 covers products and the background to trading including: trading risk; asset classes; derivatives, structures and hybrids; credit derivatives; liquidity, price and leverage. Part 2 covers the trade lifecycle including: the anatomy of a trade; the lifecycle of a trade; cashflows and asset holdings; risk management; market risk control; counterparty risk control; accounting and P&L attribution. Part 3 covers systems and procedures including;: the people; developing processes for new products; new products; systems; testing; data; reports; calculation; mathematical model and systems validation; regulatory, legal and compliance issues and business continuity planning. Finally Part 4 covers what can go wrong, discussing credit derivatives and the financial crisis.

In the aftermath of the financial crisis emphasis had moved to transparency and due diligence involving closer scrutiny of all forms of risk. In this new world order, there is a much greater analysis of every trade and all market participants will need to have a better understanding of the impact of their work on the whole trade cycle – this book provides a one stop comprehensive guide to the lifecycle of a trade.


Author’s Note.



1 Trading.

1.1 How and why do people trade?

1.2 Factors affecting trade.

1.3 Market participants.

1.4 Means by which trades are transacted.

1.5 When is a trade live?

1.6 Consequences of trading.

1.7 Trading in the financial services industry.

1.8 What do we mean by a trade?

1.9 Who works on the trade and when?

1.10 Summary.

2 Risk.

2.1 Introduction.

2.2 Risk is inevitable.

2.3 Quantifying risk.

2.4 Methods of dealing with risk.

2.5 Managing risk.

2.6 Problems of unforeseen risk.

2.7 Summary.

3 Asset Classes.

3.1 Interest rates.

3.2 Foreign exchange (FX).

3.3 Equity.

3.4 Bonds and credit.

3.5 Commodities.

3.6 Trading across asset classes.

3.7 Summary.

4 Derivatives, Structures and Hybrids.

4.1 What is a derivative?

4.2 Linear.

4.3 Nonlinear.

4.4 Some option terminology.

4.5 Option valuation.

4.6 Exotic options.

4.7 Structures and hybrids.

4.8 Importance of simpler products.

4.9 Trade matrix.

4.10 Summary.

5 Credit Derivatives.

5.1 Introduction.

5.2 CDS.

5.3 CLN.

5.4 CDO.

5.5 Data relating to CDOs.

5.6 Practical aspects of CDO management.

5.7 Practical aspects of CDO valuation.

5.8 Why are credit derivatives different?

5.9 Summary.

6 Liquidity, Price and Leverage.

6.1 Liquidity.

6.2 Price.

6.3 Leverage.


7 Anatomy of a Trade.

7.1 The underlying.

7.2 General.

7.3 Economic.

7.4 Sales.

7.5 Legal.

7.6 Booking.

7.7 Counterparty.

7.8 Timeline.

8 Lifecycle.

8.1 Pre Execution.

8.2 Execution and booking.

8.3 Confirmation.

8.4 Post booking.

8.5 Settlement.

8.6 Overnight.

8.7 Changes during lifetime.

8.8 Reporting during lifetime.

8.9 Exercise.

8.10 Maturity.

8.11 Example trade.

8.12 Summary.

9 Cashflows and Asset Holdings.

9.1 Introduction.

9.2 Holdings.

9.3 Value of holding.

9.4 Reconciliation.

9.5 Consolidated reporting.

9.6 Realised and unrealised P&L.

9.7 Diversification.

9.8 Bank within a bank.

9.9 Custody of securities.

9.10 Risks.

9.11 Summary.

10 Risk Management.

10.1 Traders.

10.2 Risk control.

10.3 Trading management.

10.4 Senior management.

10.5 How do risks arise?

10.6 Different reasons for trades.

10.7 Hedging.

10.8 What happens when the trader is not around?

10.9 Types of risk.

10.10 Trading strategies.

10.11 Hedging strategies.

10.12 Summary.

11 Market Risk Control.

11.1 Various methodologies.

11.2 Need for risk.

11.3 Allocation of risk.

11.4 Monitoring of market risk.

11.5 Controlling the risk.

11.6 Responsibilities of the market risk control department.

11.7 Limitations of market risk departments.

11.8 Regulatory requirements.

11.9 Summary.

12 Counterparty Risk Control.

12.1 Reasons for non fulfilment of obligations.

12.2 Consequences of counterparty default.

12.3 Counterparty risk over time.

12.4 How to measure the risk.

12.5 Imposing limits.

12.6 Who is the counterparty?

12.7 Collateral.

12.8 Activities of the counterparty risk control department.

12.9 What are the risks involved in analysing credit risk?

12.10 Payment systems.

12.11 Summary.

13 Accounting.

13.1 Balance sheet.

13.2 Profit and loss account.

13.3 Financial reports for hedge funds and asset managers.

14 P&L Attribution.

14.1 Benefits.

14.2 The process.

14.3 Example.

14.4 Summary.


15 People.

15.1 Traders.

15.2 Trading assistants.

15.3 Structurers.

15.4 Sales.

15.5 Researchers.

15.6 Middle office (product control).

15.7 Back office (operations).

15.8 Quantitative analyst.

15.9 Information technology.

15.10 Legal.

15.11 Model validation.

15.12 Market risk control department.

15.13 Counterparty risk control department.

15.14 Finance.

15.15 Internal audit.

15.16 Compliance.

15.17 Trading manager.

15.18 Management.

15.19 Human risks.

15.20 Summary.

16 Developing Processes for New Products (and Improving Processes for Existing Products).

16.1 What is a process?

16.2 The status quo.

16.3 How processes evolve.

16.4 Inventory of current systems.

16.5 Coping with change.

16.6 Improving the situation.

16.7 Inertia.

16.8 Summary.

17 New Products.

17.1 Origin of new products.

17.2 Trial basis.

17.3 New trade checklist.

17.4 New product evolution.

17.5 Risks.

17.6 Summary.

18 Systems.

18.1 What makes a good system?

18.2 IT procurement.

18.3 System stakeholders.

18.4 The IT team.

18.5 Timeline of a project.

18.6 Project management.

18.7 The IT divide.

18.8 Techniques and issues related to IT.

18.9 Systems architecture.

18.10 Different types of development.

18.11 Buy versus build.

18.12 Software vendors.

18.13 Performance.

18.14 Project estimation.

18.15 General thoughts on IT.

18.16 Summary.

19 Testing.

19.1 What is testing?

19.2 Why is testing important?

19.3 Who does testing?

19.4 When should testing be done?

19.5 What are the types of testing?

19.6 Fault logging.

19.7 Risks.

19.8 Summary.

20 Data.

20.1 Common characteristics.

20.2 Database.

20.3 Types of data.

20.4 Bid/offer spread.

20.5 Curves and surfaces.

20.6 Sets of market data.

20.7 Back testing.

20.8 How can data go wrong?

20.9 Typical data sources.

20.10 How to cope with corrections to data.

20.11 Data integrity.

20.12 The business risks of data.

20.13 Summary.

21 Reports.

21.1 Introduction.

21.2 What makes a good report?

21.3 Reporting requirements.

21.4 When things go wrong.

21.5 Redundancy.

21.6 Control.

21.7 Enhancement.

21.8 Security.

21.9 Risks.

21.10 Summary.

22 Calculation.

22.1 What does the calculation process actually do?

22.2 The calculation itself.

22.3 Sensitivity analysis.

22.4 Bootstrapping.

22.5 Calculation of dates.

22.6 Calibration to market.

22.7 Testing.

22.8 Integrating a model within a full system.

22.9 Risks associated with the valuation process.

22.10 Summary.

23 Mathematical Model and Systems Validation (Geoff Chaplin).

23.1 Testing procedures.

23.2 Implementation and documentation.

23.3 Summary.

24 Regulatory, Legal and Compliance.

24.1 Regulatory requirements.

24.2 Legal.

24.3 Compliance.

24.4 Risks.

24.5 Summary.

25 Business Continuity Planning.

25.1 What is business continuity planning?

25.2 Why is it important?

25.3 Types of disaster.

25.4 How does it work?

25.5 Risks associated with BCP.

25.6 Summary.


26 Credit Derivatives and the Crisis of 2007 (Robert Reoch).

26.1 Background.

26.2 The events of mid-2007.

26.3 Issues to be addressed.

26.4 Summary.

Appendix: Summary of Risks.

General comment – unforeseen risk.

Operational risk (in the trade lifecycle).

Human risks.

Market risk control.

Counterparty risk control.




New products.

Legal and regulatory.


Business continuity planning (BCP).

Valuation and model approval.



Front office.


IT and systems.

Effective control and support.

Recommended Reading.