The BBA met on Friday to review how the different "ibor" rates are set. It went something like this:
"Well mates, what do we think?"
"I think it's too bloody late. Why did we have to meet at 5pm on a friday to discuss this piss."
"It's those American gits. They think they're the center of the world, so our BRITISH Banker's Association meeting has to meet when it's convenient for them--noon New York time."
"I thought it was supposed to be noon GMT, I was here five hours ago."
(laughter)
"Yea, it was noon Greenwich Mean Time, by which I mean Greenwich Connecticut."
(laughter)
"Alright boys, settle down. So what do we think. The world's making a big deal about LIBOR rates. Doesn't seem they care much about the other rates."
"So we agree that all the other rates will remain the same? All those in favor?"
"AYE!" (all in unison)
"Well, that's settled."
"On to LIBOR, then. There are several options on the table. 1) we claim to keep a close regulatory eye on the banks submitting rates, which will probably keep libor rates high and not change much. 2) we can add a few American banks to the mix, which will probably lower rates a little bit. 3) we can suggest a market based approach, like that used for Euribor. 4) we do nothing."
"Let the American gits suffer and leave it be."
"I say we don't change anything. It's worked this long, why should we change it now? The system is perfect, we just have to let it shake itself out."
"I say we put more pressure on the banks to submit true libor rates or we switch to a market based structure."
"What, are you limit short eurodollars in your PA or something?"
(laughter)
"uh. . . no. . . I'm not a market participant. . . that'd be. . .uh. . .unethical. . ."
"Why don't we just watch it longer? The panic over libor seems to be settling down. Maybe we can wait it out and not have to do anything?"
"Yea, if we have to change something, we can always tape-bomb them later."
(laughter)
"Preferably we can tape bomb them in the morning so the Americans have to get up in the middle of the night to figure it out. You can imagine Colin Corgan (head US swaps trader, GS) getting that call in the middle of the night and having to throw off some blonde hooker to get to a computer."
(more laughter)
"Settle down now."
"I say it's getting too late. We can let's leave this up to another day and head down to the pub."
"AYE!"
"Okay, okay. Are we all in favor of calling it a day and going down to the pub?"
(it was known to be a rhetorical question so they all file out.)
"Hey, who's going to do the press release?"
"Thanks for volunteering. We'll see you at the pub."
Saturday, May 31, 2008
Monday, May 26, 2008
A Swapper's Paradigm
So a lot has changed since I last blogged. Most notably, the market has found two major deficiencies with the current conventions and ripped a hole straight through them. The first is the mortgage market and how the agencies work to keep order in the mortgage world. I'll write about that another time. The most fascinating change in my opinion (being a rates derivatives guy) is the changes that have happened in libor space.
Libor (the London Interbank Offer Rate), which I've touched on briefly in my Rates "Learn the Lingo" (http://getonthedesk.blogspot.com/2007/06/learn-lingo-rates.html), has seen some dramatic swings. Swap guys pay very close attention to libor because swap payments are set off of libor. While fixed payments are made at whatever rate was agreed upon, the float payments usually reset every three months according to whatever level the three month libor rate set that day.
Libor sets through something of a committee. Basically a bunch of member banks (16, I think) contribute rates at which they say they would offer to lend unsecured cash to other member banks. The top four and bottom four rates are discarded and the simple average is taken of the remaining eight. It is set sometime around 11:45 london time. Many tenors are published from overnight to one year. The most important are usually the overnight rate and the three month rate.
It's worth noting that the rates published by each bank are not necessarily the rates at which they actually lent money nor the rates at which they actually borrowed money (that seems kinda dumb to anyone? Yea, thought it might.). People had pointed out this deficiency before, but it never actually became an issue until recently. Swap and repo guys will know about turn of year funding issues, where year-end (literally dec 31st) and month end funding cost more because companies have to balance their accounting statements. Funding on those days are particularly expensive. The fed has had to flood the financial system with liquidity (read: give away money for free) on these days at times of crises to prevent companies from being unable to fund themselves (thus going bankrupt).
It turns out that this year a whole lot of these sorts of issues were happening and the liquidity of several companies were doubted. We've all heard of Bear Stearns and the "run on the bank" they had, making the older folks remenisce back to the Great Depression days when such runs on banks were common. Those involved also would have seen a similar process (and many rumors) take place with Lehman, although they turned out quite fine.
Libor starting setting higher and higher as banks started to hoard their cash. In fact, it got so bad that at one point the Fed having cut 100bps had completely priced out of the libor market. That is, libor was setting as high as it was when fed funds were 100bps higher. That was both ridiculous and showed how damaged the sytem was. Then the Fed came out with some of their cool toys, most notably the TAF and the dealer lending facility (the name of which evades me at the moment), to inject liquidity without lowering the funds rate. Down came libor again as panic averted and we came back into a "normal" market environment (or as normal as you can say 20bp moves every other day are).
At one point, the allegations came out about banks lying about where they were funding via the libor rates they contributed. Ironically, I think the most publicized version of this allegation came from a Citi analyst. Well, shortly thereafter libor rates started to skyrocket again as scrutiny around libor made member banks carefully set their libor closer to where they actually funded themselves (and citi's new libor rate was much, much higher).
At this point it might be worth noting that or "IBOR" rates aren't as retarded as LIBOR. Some of them, like Euribor, are set via a market rate or market average. That kind of makes sense, doesn't it? To be able to actually see where the rate should be via market transactions. Well, some people really started to notice this as their funding rates went through the roof and trounced their income margins.
Lately a movement has begun to move the derivatives market away from libor. The action itself makes sense, and a gradual transition of swaps and other derivatives away from libor would probably work. Specifically Goldman has suggested that OIS become the new benchmark rate.
What's OIS? OIS stands for Overnight Index Swap. No, that's not helpful. OIS is a swap that goes off of the fed funds effective rate (the rate at which banks lends excess balances to the Fed overnight--basically banks with more cash on hand than required can make a bit of excess interest rate by keeping it at the Fed). The fed funds effective rate is a transactional rate that anyone can observe (well, anyone involved in the markets, at least). The fed funds effective rate usually stays very close to the fed funds target rate, which is the rate the fed announces their policy cuts around at those FOMC meetings.
OIS swaps already trade a bit in the market, but libor swaps still dominate. OIS swaps make sense for people who are hedging, and the uncertanty around reset risk would go away for both dealers and counterparties. The overnight money markets are less active these days and there are usually very few longer dated transactions anyway (for example, why would a bank ever lend for 6months or a year at libor? It seems silly. The only rate really observable was the overnight rate for libor.). OIS, being tied to the specific set of fed funds effective rates, would make the value of interest rate derivatives much easier to predict.
It will be interesting to see if OIS ends up becoming the new libor over the next year or so. It seems the transition will be slow, and it will be a difficult transition to force. If all the dealers agree to trade OIS swaps instead of libor swaps, they'd still have to get customers to convert. For most institutions it probably makes sense to use OIS, especially those who are hedging rate risk for a balance sheet (specifically bank portfolios funding at the fed funds rate, which are a major player in swap space). For other institutions (i.e. industrial companies), it probably doesn't matter as long as they get some sort of interest rate exposure. Personally, I'd say never bet against those Goldman folks.
Libor (the London Interbank Offer Rate), which I've touched on briefly in my Rates "Learn the Lingo" (http://getonthedesk.blogspot.com/2007/06/learn-lingo-rates.html), has seen some dramatic swings. Swap guys pay very close attention to libor because swap payments are set off of libor. While fixed payments are made at whatever rate was agreed upon, the float payments usually reset every three months according to whatever level the three month libor rate set that day.
Libor sets through something of a committee. Basically a bunch of member banks (16, I think) contribute rates at which they say they would offer to lend unsecured cash to other member banks. The top four and bottom four rates are discarded and the simple average is taken of the remaining eight. It is set sometime around 11:45 london time. Many tenors are published from overnight to one year. The most important are usually the overnight rate and the three month rate.
It's worth noting that the rates published by each bank are not necessarily the rates at which they actually lent money nor the rates at which they actually borrowed money (that seems kinda dumb to anyone? Yea, thought it might.). People had pointed out this deficiency before, but it never actually became an issue until recently. Swap and repo guys will know about turn of year funding issues, where year-end (literally dec 31st) and month end funding cost more because companies have to balance their accounting statements. Funding on those days are particularly expensive. The fed has had to flood the financial system with liquidity (read: give away money for free) on these days at times of crises to prevent companies from being unable to fund themselves (thus going bankrupt).
It turns out that this year a whole lot of these sorts of issues were happening and the liquidity of several companies were doubted. We've all heard of Bear Stearns and the "run on the bank" they had, making the older folks remenisce back to the Great Depression days when such runs on banks were common. Those involved also would have seen a similar process (and many rumors) take place with Lehman, although they turned out quite fine.
Libor starting setting higher and higher as banks started to hoard their cash. In fact, it got so bad that at one point the Fed having cut 100bps had completely priced out of the libor market. That is, libor was setting as high as it was when fed funds were 100bps higher. That was both ridiculous and showed how damaged the sytem was. Then the Fed came out with some of their cool toys, most notably the TAF and the dealer lending facility (the name of which evades me at the moment), to inject liquidity without lowering the funds rate. Down came libor again as panic averted and we came back into a "normal" market environment (or as normal as you can say 20bp moves every other day are).
At one point, the allegations came out about banks lying about where they were funding via the libor rates they contributed. Ironically, I think the most publicized version of this allegation came from a Citi analyst. Well, shortly thereafter libor rates started to skyrocket again as scrutiny around libor made member banks carefully set their libor closer to where they actually funded themselves (and citi's new libor rate was much, much higher).
At this point it might be worth noting that or "IBOR" rates aren't as retarded as LIBOR. Some of them, like Euribor, are set via a market rate or market average. That kind of makes sense, doesn't it? To be able to actually see where the rate should be via market transactions. Well, some people really started to notice this as their funding rates went through the roof and trounced their income margins.
Lately a movement has begun to move the derivatives market away from libor. The action itself makes sense, and a gradual transition of swaps and other derivatives away from libor would probably work. Specifically Goldman has suggested that OIS become the new benchmark rate.
What's OIS? OIS stands for Overnight Index Swap. No, that's not helpful. OIS is a swap that goes off of the fed funds effective rate (the rate at which banks lends excess balances to the Fed overnight--basically banks with more cash on hand than required can make a bit of excess interest rate by keeping it at the Fed). The fed funds effective rate is a transactional rate that anyone can observe (well, anyone involved in the markets, at least). The fed funds effective rate usually stays very close to the fed funds target rate, which is the rate the fed announces their policy cuts around at those FOMC meetings.
OIS swaps already trade a bit in the market, but libor swaps still dominate. OIS swaps make sense for people who are hedging, and the uncertanty around reset risk would go away for both dealers and counterparties. The overnight money markets are less active these days and there are usually very few longer dated transactions anyway (for example, why would a bank ever lend for 6months or a year at libor? It seems silly. The only rate really observable was the overnight rate for libor.). OIS, being tied to the specific set of fed funds effective rates, would make the value of interest rate derivatives much easier to predict.
It will be interesting to see if OIS ends up becoming the new libor over the next year or so. It seems the transition will be slow, and it will be a difficult transition to force. If all the dealers agree to trade OIS swaps instead of libor swaps, they'd still have to get customers to convert. For most institutions it probably makes sense to use OIS, especially those who are hedging rate risk for a balance sheet (specifically bank portfolios funding at the fed funds rate, which are a major player in swap space). For other institutions (i.e. industrial companies), it probably doesn't matter as long as they get some sort of interest rate exposure. Personally, I'd say never bet against those Goldman folks.
I'm back
I'd been away from blogging for a while as I spent a lot of time redeveloping our trading desk's risk systems. I think I'm one of the few traders who really get's my hands dirty when new ideas come up. I spent a lot of time rebuilding how we see our risk, how we view the market (i.e. market monitors) and how we build our curves. It was a long process, but I finally feel pretty confortable with our systems. Just needed a bit of a push and support from above to turn everything upside-down.
Unfortunately doing development work is difficult during the trading day, so I spent a lot of my evenings and weekends building tools. It's good to be back in the game though. Trading more actively (and more products) than ever. Hopefully it will give me plenty of material to blog about as well.
No promises that I keep breaking this time, but I will try to remain active in this blog.
Cheers,
QT
Unfortunately doing development work is difficult during the trading day, so I spent a lot of my evenings and weekends building tools. It's good to be back in the game though. Trading more actively (and more products) than ever. Hopefully it will give me plenty of material to blog about as well.
No promises that I keep breaking this time, but I will try to remain active in this blog.
Cheers,
QT
Monday, February 25, 2008
Change is Good
One of things Wall Streeters seem to fear the most is change. New organizational structures, new bosses, new underlings. Well. . . I suppose the underlings usually don't scare people. All things considered though, these things should be seen as opportunities. Of course, constant organizational changes are just disruptive, but the occaisional shake-up can definitely be something to take advantage of.
New bosses give the opportunity for advancement. Having a new manager puts everyone on the same footing again. If you weren't in the limelight before, now you can be. If you were the boss's right-hand guy before, you get to show you were there because you're that good, not because you were his buddy. It's usually more the latter that find these situations fearful. I have found that the guy who can steadily be the number 2 guy though several organizational changes usually gets the next promotion. He's proven that he is the best guy for the job through several regimes. The changes just give an extra early opportunity to prove it.
Sometimes the fear comes because the company is cutting back. Well, that fear may be justified. There are times when good producers are let go for poor or unrelated reasons. You may feel you were unfairly let go or a friend was unfairly let go. If you were unfairly let go, well. . . can't do much there other than look for your next career move. If your friend was let go, you still need to view it as an opportunity for advancement. If you think it was truly unfair, you vote with your feet. Leave institutions that practice unfair human capital mangement and join institutions that treat talent as it should be treated.
New bosses give the opportunity for advancement. Having a new manager puts everyone on the same footing again. If you weren't in the limelight before, now you can be. If you were the boss's right-hand guy before, you get to show you were there because you're that good, not because you were his buddy. It's usually more the latter that find these situations fearful. I have found that the guy who can steadily be the number 2 guy though several organizational changes usually gets the next promotion. He's proven that he is the best guy for the job through several regimes. The changes just give an extra early opportunity to prove it.
Sometimes the fear comes because the company is cutting back. Well, that fear may be justified. There are times when good producers are let go for poor or unrelated reasons. You may feel you were unfairly let go or a friend was unfairly let go. If you were unfairly let go, well. . . can't do much there other than look for your next career move. If your friend was let go, you still need to view it as an opportunity for advancement. If you think it was truly unfair, you vote with your feet. Leave institutions that practice unfair human capital mangement and join institutions that treat talent as it should be treated.
Saturday, February 16, 2008
Pop Culture and Wall Street
In my opinion finance has never really been part of pop culture. In fact, the stereotypical "finance geek" has been the paradigm of un-cool in the world. Sure, there is the occaisional film about the finance world (Wall Street, Boiler Room, Trading Places), but those are really financial world cult classics. The average person doesn't really care much for them. Recently, however, I have come across a strange phenomenon. Wall Street is really becoming part of main street.
Why did I come to this conclusion? It's a long weekend, and I was watching a new pop-culture phenomenon over lunch. I watched an episodes of this new show "Gossip Girl" online over lunch (don't ask). While I probably won't be watching another episode, it did provide me with some amusing insights into pop culture.
Normal people don't use the term "done" in normal conversation other than "I'd like my steak well done." These kids were regularly using "done" as a phrase in itself to communicate something being agreed upon. I think this clearly came from the trader's lexicon: "Bid fifty ten year notes." "Done." Normal people don't talk like that. Only market players talk like that. Apparently though, the new breed of teens out there are. Interesting, no? Maybe I'm extrapolating too much about pop culture from one episode of some teen show, but I don't think I'm extrapolating too much. Media does define language, afterall.
I suppose this progression is not too surprising with how much press Wall Street is getting lately. Hedge funds and investment banks are becoming part of everyday conversation. They're constantly in the news, and while they always stood as an illustration of wealth/greed they now stand as the glorified exemplars of wealth creation. Everyone thinks of bankers/traders and associates them with wealth and excitement. Well. . . maybe not so much excitement but some form of living the dream life. It's like investment types are starting to gain rock-star status.
Why did I come to this conclusion? It's a long weekend, and I was watching a new pop-culture phenomenon over lunch. I watched an episodes of this new show "Gossip Girl" online over lunch (don't ask). While I probably won't be watching another episode, it did provide me with some amusing insights into pop culture.
Normal people don't use the term "done" in normal conversation other than "I'd like my steak well done." These kids were regularly using "done" as a phrase in itself to communicate something being agreed upon. I think this clearly came from the trader's lexicon: "Bid fifty ten year notes." "Done." Normal people don't talk like that. Only market players talk like that. Apparently though, the new breed of teens out there are. Interesting, no? Maybe I'm extrapolating too much about pop culture from one episode of some teen show, but I don't think I'm extrapolating too much. Media does define language, afterall.
I suppose this progression is not too surprising with how much press Wall Street is getting lately. Hedge funds and investment banks are becoming part of everyday conversation. They're constantly in the news, and while they always stood as an illustration of wealth/greed they now stand as the glorified exemplars of wealth creation. Everyone thinks of bankers/traders and associates them with wealth and excitement. Well. . . maybe not so much excitement but some form of living the dream life. It's like investment types are starting to gain rock-star status.
Friday, February 15, 2008
Between Jobs
Getting lots of e-mails and calls from people who are looking for jobs these days. Some are fresh out of school but finding the current hiring environment difficult, others are veterans recently laid-off due to "cost cutting." What should you do when you're between jobs?
Well, I suppose it depends on the person. First off, a safe bet for someone straight out of school is to go find some productive job. Just make sure it's related. Financial consulting is a popular choice. Another is working for a financial research or financial software firm. Just keeping a hand in financial products helps.
Always be tracking what markets are doing and always be growing your network of people in the industry. The number one way into the industry is through connections. Don't be afraid to bug them fairly regularly (like once every 3-6 months, not once a week).
Some people help their resumes along during such periods by trading a small PA (personal account) and tracking returns or publishing a newsletter/blog regularly to anyone who will read. Such activities, while not really jobs at that point, help keep you up-to-date in the industry. They help you build some experience working some aspect of the industry and feeling the joys and pains of being right or wrong. Ultimately it also helps you attract people who are interested in people like you.
What if you've worked for a bit? That largely depends on what you did.
Traders and some salespeople might be perfectly fine trading their own acount for a while between jobs. I know plenty of people who enjoy trading their PA (Personal Account) enough to use it as a temporary job. Some of those people end up enjoying it enough to just do that forever. Depending on the risk profile of the trader he may trade a cash account or a futures/margin account. I'm a fan of the futures account. Some traders move on to sales or risk roles after their first lay-off. They find those jobs easier to find, and their experience as a risk taker gives them most respect as a salesperson or risk manager.
Some people go off to start their own firms. I know risk managers who started software companies, traders who started brokerages, and salespeople who started newsletter services. Each has its own appeal, but generally I think these people were fairly well-off and wanted the freedom of having their own shop.
Find something productive to do. Grow your skills. You'll find no new skill gained is ever wasted.
Well, I suppose it depends on the person. First off, a safe bet for someone straight out of school is to go find some productive job. Just make sure it's related. Financial consulting is a popular choice. Another is working for a financial research or financial software firm. Just keeping a hand in financial products helps.
Always be tracking what markets are doing and always be growing your network of people in the industry. The number one way into the industry is through connections. Don't be afraid to bug them fairly regularly (like once every 3-6 months, not once a week).
Some people help their resumes along during such periods by trading a small PA (personal account) and tracking returns or publishing a newsletter/blog regularly to anyone who will read. Such activities, while not really jobs at that point, help keep you up-to-date in the industry. They help you build some experience working some aspect of the industry and feeling the joys and pains of being right or wrong. Ultimately it also helps you attract people who are interested in people like you.
What if you've worked for a bit? That largely depends on what you did.
Traders and some salespeople might be perfectly fine trading their own acount for a while between jobs. I know plenty of people who enjoy trading their PA (Personal Account) enough to use it as a temporary job. Some of those people end up enjoying it enough to just do that forever. Depending on the risk profile of the trader he may trade a cash account or a futures/margin account. I'm a fan of the futures account. Some traders move on to sales or risk roles after their first lay-off. They find those jobs easier to find, and their experience as a risk taker gives them most respect as a salesperson or risk manager.
Some people go off to start their own firms. I know risk managers who started software companies, traders who started brokerages, and salespeople who started newsletter services. Each has its own appeal, but generally I think these people were fairly well-off and wanted the freedom of having their own shop.
Find something productive to do. Grow your skills. You'll find no new skill gained is ever wasted.
Saturday, February 9, 2008
Building Your Personal Network
We traders tend to understate the importance of networking compared to salespeople, bankers and other investment/finance types. In truth though, building your personal network can be one of the most important moves even as a trader. Of course your PnL will speak for itself, but your network can speed up your progress serveral-fold. All new finance analysts/associates should be purposefully building a network of people that will be helpful in the future.
Here's a list of who you should try to befriend:
1) All your salespeople, brokers and/or clients. Depending on your role you will either have sales-coverage, brokers, clients or some combination of the three. They are the first set of people you should befriend. Meet outside work. Go out clubbing/barhopping together. See an occasional movie. Have dinner. The more you interact with these people on a personal level, the better it will be for your current role and for future prospective roles. I can't tell you the number of people I know who made great job changes because their broker, sales-coverage or client decided to either reccommend them or hire them straight-out.
2) Two to three up-and-comming big shots. There are a few on every floor. Those people who are clearly favored by management, are producers, and are about to make it into a big role. Everyone wants to be the corner office's friend, but the easiest way to being on walk-in chat terms with the corner office guy is to be his buddy before he gets there. This takes some speculation and perhaps is a bit calculating, but it can pay off big. I think your best bets are principals/SVPs who are about to make MD or MDs who sit on the floor who are about to get a managerial or C-level position. They tend to be interesting people who make great friends anyway. An extra bonus that they're about to become really important. To some people, this actually comes naturally--the people they befriend tend to become important.
3) The Admins. Have you read the book Monkey Business? I'm sure you have. Well, you know how they say the production people (copiers, printers, binders, mailroom whatever you may call them) need to be your best friend? The floor admin should be your best friend too. On many levels they hold the keys to the floor. They know schedules, events, passwords, relationships, the whole shebang. You can gain a surprising amount of leverage, support and knowledge by having frequent chats with your admins.
4) Rockstar junior people. As you get senior, you want to have the new rockstar analysts and associates be your friend. It's those people who are going to propel into big important roles, so they're worth knowing. Even better, if you befriend them you might eventually get to hire them into your group. The key to a strong franchise is getting the right people.
5) Peers. Know the people from your entering class. They will be with you and grow with you throughout your career. Some of them will continue on to become great people and do great things. Some will remain trusted mates and be around when you need a hand.
6) The office "hotties." Unfortunately this is mostly for guys, and it reflects how chauvinistic and male dominated the industry still is. As wrong as the state of things may be, that doesn't mean you shouldn't take advantage of it. The fact of the matter is the industry is dominated by guys. Guys also respect (consciuosly or unconsciously) guys who are with hot girls. Just being friends with the most attractive girls on the floor and frequently having conversations with them gains the floor's respect. Odd, but true. Okay, maybe not that odd. Just a quirk of society I guess.
Some of these recommendations may seem shallow or calculating, but they are just some part of building your in-house network that I've observed. I'm the least politically correct person I know. I despise office politics. I don't come across as a friendly person. I do, however, respect that there are some rules that can be broken and others that you just need to take advantage of. Just trying to tell it as I've seen it.
Here's a list of who you should try to befriend:
1) All your salespeople, brokers and/or clients. Depending on your role you will either have sales-coverage, brokers, clients or some combination of the three. They are the first set of people you should befriend. Meet outside work. Go out clubbing/barhopping together. See an occasional movie. Have dinner. The more you interact with these people on a personal level, the better it will be for your current role and for future prospective roles. I can't tell you the number of people I know who made great job changes because their broker, sales-coverage or client decided to either reccommend them or hire them straight-out.
2) Two to three up-and-comming big shots. There are a few on every floor. Those people who are clearly favored by management, are producers, and are about to make it into a big role. Everyone wants to be the corner office's friend, but the easiest way to being on walk-in chat terms with the corner office guy is to be his buddy before he gets there. This takes some speculation and perhaps is a bit calculating, but it can pay off big. I think your best bets are principals/SVPs who are about to make MD or MDs who sit on the floor who are about to get a managerial or C-level position. They tend to be interesting people who make great friends anyway. An extra bonus that they're about to become really important. To some people, this actually comes naturally--the people they befriend tend to become important.
3) The Admins. Have you read the book Monkey Business? I'm sure you have. Well, you know how they say the production people (copiers, printers, binders, mailroom whatever you may call them) need to be your best friend? The floor admin should be your best friend too. On many levels they hold the keys to the floor. They know schedules, events, passwords, relationships, the whole shebang. You can gain a surprising amount of leverage, support and knowledge by having frequent chats with your admins.
4) Rockstar junior people. As you get senior, you want to have the new rockstar analysts and associates be your friend. It's those people who are going to propel into big important roles, so they're worth knowing. Even better, if you befriend them you might eventually get to hire them into your group. The key to a strong franchise is getting the right people.
5) Peers. Know the people from your entering class. They will be with you and grow with you throughout your career. Some of them will continue on to become great people and do great things. Some will remain trusted mates and be around when you need a hand.
6) The office "hotties." Unfortunately this is mostly for guys, and it reflects how chauvinistic and male dominated the industry still is. As wrong as the state of things may be, that doesn't mean you shouldn't take advantage of it. The fact of the matter is the industry is dominated by guys. Guys also respect (consciuosly or unconsciously) guys who are with hot girls. Just being friends with the most attractive girls on the floor and frequently having conversations with them gains the floor's respect. Odd, but true. Okay, maybe not that odd. Just a quirk of society I guess.
Some of these recommendations may seem shallow or calculating, but they are just some part of building your in-house network that I've observed. I'm the least politically correct person I know. I despise office politics. I don't come across as a friendly person. I do, however, respect that there are some rules that can be broken and others that you just need to take advantage of. Just trying to tell it as I've seen it.
Saturday, January 19, 2008
Credit Recession
It is said that a credit-driven recessions are the worst of the recessions. They happen extremely infrequently, but when they happen they tend to be far worse than the usual recessions. Recessions tend to happen every 3-5 years. Usually they last about a year and wipe out maybe 10-20% of equity gains (for lack of better yard-stick to measure the "severity" of a recession).
Credit recessions tend to impact the sytem much more heavily. They tend not only to give the equity markets a whallop, but they also leave lasting marks on the financial landscape. During a typical recession a few companies go out of business, usually those with operating cash-flow issues, and the rest move on the create record profits a few years later. Credit recessions are a different beast all together though. Major companies get wiped out, banks go under in droves, and the way in which credit is extended as well as managed changes. It is said that the California banking industry is still recovering from the last credit recession, which was probably 1990-1991. Too bad for them because a lot of signs are saying we're hitting another one.
So what's so bad about a credit recession? Unlike a normal recession, they are led by banks. When credit blows up, banks tighten up their purse-strings. That means banks stop lending as freely, and they do so by making their interest rates (credit spreads) prohibitively high. Then companies stop spending because they can't finance new investments with debt any more. The equity markets tighten up because earnings suck. Suddenly the economy stops cold. Companies go under in droves because they can't get adequate funding and aren't selling their goods/services as robustly, which further affects banks and makes them widen credit spreads even more. It's a pretty disasterous cycle. At the end of the day, usually a few dozen banks go under, sometimes insurers and other financials go with them.
It looks like this time around the subprime mortgage hit may have started an unfortunate chain reaction. Losing money on subprime has made banks wary of their balance sheet issues. If they lose money on the subprime mortgage stuff, then suddenly they have to defend the amount of balance sheet they are keeping. They do so by raising interest rates and not lending out as freely as they did before. Thus we start down the cycle that I described above.
We are already seeing the effects on our financial landscape. The behemoth Citigroup has all but died, their stock price back to levels seen in the last recession. They moved from #1 in market cap to #3 in the last year or so (they were passed by Bank of America somewhat before this credit blow-out and were passed by JP Morgan just a few days ago). It looks like SIVs (Structured Investment Vehicles--I'll do a Learn the Lingo on these at some point, I may have mentioned them in another Learn the Lingo post) may "go the way of the dinosaur" as they say. Banks will have to deal with those assets on their balance sheets instead of structuring them and spinning them into their own entities. Monoline insurers are looking pretty precarious right now as the first one (Ambac) just got downgraded from AAA. I'll also try to do a Learn the Lingo on monoline insurers, but the main issue is that they insure municipal bonds. They are absolutely useless if they don't have that AAA rating because why would you want anything other than a AAA rated company insuring a state/municipality? Ambac is the second biggest insurer, and people are already talking about the biggest insurer, MBIA, also being in trouble. Bad times.
So that's where we stand now. Credit recession or not, it looks like our financial landscape has changed once again. It'll be interesting to see what happens to CDOs, subprime mortgages and other financial instruments that were hit so hard this time around. Knowing Wall Street though, they'll always find a good way to get in trouble again. In fact, those same instruments may well find their place back in the markets in due time.
Credit recessions tend to impact the sytem much more heavily. They tend not only to give the equity markets a whallop, but they also leave lasting marks on the financial landscape. During a typical recession a few companies go out of business, usually those with operating cash-flow issues, and the rest move on the create record profits a few years later. Credit recessions are a different beast all together though. Major companies get wiped out, banks go under in droves, and the way in which credit is extended as well as managed changes. It is said that the California banking industry is still recovering from the last credit recession, which was probably 1990-1991. Too bad for them because a lot of signs are saying we're hitting another one.
So what's so bad about a credit recession? Unlike a normal recession, they are led by banks. When credit blows up, banks tighten up their purse-strings. That means banks stop lending as freely, and they do so by making their interest rates (credit spreads) prohibitively high. Then companies stop spending because they can't finance new investments with debt any more. The equity markets tighten up because earnings suck. Suddenly the economy stops cold. Companies go under in droves because they can't get adequate funding and aren't selling their goods/services as robustly, which further affects banks and makes them widen credit spreads even more. It's a pretty disasterous cycle. At the end of the day, usually a few dozen banks go under, sometimes insurers and other financials go with them.
It looks like this time around the subprime mortgage hit may have started an unfortunate chain reaction. Losing money on subprime has made banks wary of their balance sheet issues. If they lose money on the subprime mortgage stuff, then suddenly they have to defend the amount of balance sheet they are keeping. They do so by raising interest rates and not lending out as freely as they did before. Thus we start down the cycle that I described above.
We are already seeing the effects on our financial landscape. The behemoth Citigroup has all but died, their stock price back to levels seen in the last recession. They moved from #1 in market cap to #3 in the last year or so (they were passed by Bank of America somewhat before this credit blow-out and were passed by JP Morgan just a few days ago). It looks like SIVs (Structured Investment Vehicles--I'll do a Learn the Lingo on these at some point, I may have mentioned them in another Learn the Lingo post) may "go the way of the dinosaur" as they say. Banks will have to deal with those assets on their balance sheets instead of structuring them and spinning them into their own entities. Monoline insurers are looking pretty precarious right now as the first one (Ambac) just got downgraded from AAA. I'll also try to do a Learn the Lingo on monoline insurers, but the main issue is that they insure municipal bonds. They are absolutely useless if they don't have that AAA rating because why would you want anything other than a AAA rated company insuring a state/municipality? Ambac is the second biggest insurer, and people are already talking about the biggest insurer, MBIA, also being in trouble. Bad times.
So that's where we stand now. Credit recession or not, it looks like our financial landscape has changed once again. It'll be interesting to see what happens to CDOs, subprime mortgages and other financial instruments that were hit so hard this time around. Knowing Wall Street though, they'll always find a good way to get in trouble again. In fact, those same instruments may well find their place back in the markets in due time.
Saturday, January 12, 2008
Learn the Lingo (Optionality and Greeks)
Derivatives are a booming business these days, and I figured I've yet to talk about options and the ways we describe them. It's been a while since I've done a real "learn the lingo" post.
People talk about the greeks all the time (not referring to their frat/sorority buddies), but it seems precious few outside the derivatives world understand what they're talking about. Actually, precious few IN the derivatives world understand what they're talking about. Try to avoid being one of those people. Do note that I use the term "derivative" both in referring to derivative contracts and in referring to the mathematical derivative. I'm sure you'll figure out when I'm using it in each way, but do ask if my writing is confusing.
Call Option - a contract to enter into the right to buy something at a set price.
Put Option - a contract to enter into the right to sell something at a set price.
Future - a contract, usually on an exchange, allowing one to buy X units of something at the price the contract was transacted.
OTC - Over-the-Counter, refering to transactions done as deals between entities as opposed to exchange traded, thus making the market for such transactions more opaque.
Forward - a contract, usually OTC, to buy X units of something at a set price.
Delta - the sensitivity of a derivative to a small move in the underlying reference material. Sometimes delta is used to refer to the trading of the reference material itself. The reference material can be an underlying security, a commodity, a rate, even some economic variable. Delta is also the first derivative of the price of a contract with respect to the underlying reference material (remember from Calculus that the first derivative is the slope of a curve? Notice how a the slope approximates a small move in the y coordinate due to a small move in the x coordinate?).
Gamma - the second derivative of a contract with respect to the underlying reference. This shows the sensitivity of the price of a contract to large moves in the underlying. It is the curvature of the price sensitivity graph. Do you remember doing Taylor approximations in Calculus? Delta and gamma (the first and second derivative of the price of a contract with respect to it's underlying) are often used to find the price of a contract after a move in the underlying via Taylor approximation. The important concept, however, is that gamma refers to the sensitivity of a contract to large moves in the underlying.
Theta - option decay. Options are worth more when there is a lot of time before they expire. It shouldn't be surprising that the longer you have the option, the more it's worth.
Vega - the sensitivity of a contract to the volatility of the underlying reference. This is often a parameter in pricing models, but conceptually it refers to how much more a contract is worth when the underlying reference material becomes more volatile. Most options are worth more with volatility. In fact, option traders are often referred to as vega or vol traders.
Rho - the sensitivity of a contract to the underlying interest rate assumption. This is important because the interest rate changes the discount factor of value over time.
Black-Scholes - The Black-Scholes model has been the benchmark option pricing model since it's inception. It incorporates all the greeks above. In fact, it pretty much gave birth to the greeks.
People talk about the greeks all the time (not referring to their frat/sorority buddies), but it seems precious few outside the derivatives world understand what they're talking about. Actually, precious few IN the derivatives world understand what they're talking about. Try to avoid being one of those people. Do note that I use the term "derivative" both in referring to derivative contracts and in referring to the mathematical derivative. I'm sure you'll figure out when I'm using it in each way, but do ask if my writing is confusing.
Call Option - a contract to enter into the right to buy something at a set price.
Put Option - a contract to enter into the right to sell something at a set price.
Future - a contract, usually on an exchange, allowing one to buy X units of something at the price the contract was transacted.
OTC - Over-the-Counter, refering to transactions done as deals between entities as opposed to exchange traded, thus making the market for such transactions more opaque.
Forward - a contract, usually OTC, to buy X units of something at a set price.
Delta - the sensitivity of a derivative to a small move in the underlying reference material. Sometimes delta is used to refer to the trading of the reference material itself. The reference material can be an underlying security, a commodity, a rate, even some economic variable. Delta is also the first derivative of the price of a contract with respect to the underlying reference material (remember from Calculus that the first derivative is the slope of a curve? Notice how a the slope approximates a small move in the y coordinate due to a small move in the x coordinate?).
Gamma - the second derivative of a contract with respect to the underlying reference. This shows the sensitivity of the price of a contract to large moves in the underlying. It is the curvature of the price sensitivity graph. Do you remember doing Taylor approximations in Calculus? Delta and gamma (the first and second derivative of the price of a contract with respect to it's underlying) are often used to find the price of a contract after a move in the underlying via Taylor approximation. The important concept, however, is that gamma refers to the sensitivity of a contract to large moves in the underlying.
Theta - option decay. Options are worth more when there is a lot of time before they expire. It shouldn't be surprising that the longer you have the option, the more it's worth.
Vega - the sensitivity of a contract to the volatility of the underlying reference. This is often a parameter in pricing models, but conceptually it refers to how much more a contract is worth when the underlying reference material becomes more volatile. Most options are worth more with volatility. In fact, option traders are often referred to as vega or vol traders.
Rho - the sensitivity of a contract to the underlying interest rate assumption. This is important because the interest rate changes the discount factor of value over time.
Black-Scholes - The Black-Scholes model has been the benchmark option pricing model since it's inception. It incorporates all the greeks above. In fact, it pretty much gave birth to the greeks.
Sunday, January 6, 2008
Day in the life of a Quant
A couple people have asked for something along these lines. I'm going to do two versions of this. "Quants" are an overly generalized term, so there really are multiple types of quants. There are quants that support derivatives desks, there are quants that do statistics for proprietary trading, and there are quants that build apps for use by an institution. I really only know anything about the first two.
Exotic Derivatives Quant:
5:45am - get up, shower
6:30am - be on train
7:00am - get to office
7:10am - deal with first trader complaint. A pricing module for knockout options on fx broke.
7:30am - morning call with traders, quants and sales people
7:45am - work on forward discount curve for dollar denominated assets.
8:20am - first trade of the day comes in. A European bank wants to price a equity index basket option. You start on the code immediately (VBA or C++, depending on the difficulty of the basket/option being priced and also depending on the bank from what I've heard).
9:00am - finished writing and debugging code. Go to your validating quant to check work. (Usually two quants will work on a given model at the same time. If both models get to the same answer within a certian tolerance, then the code is considered good).
9:20am - your code and validation code match up, code is sent to the model validation quants (usually yet another group that compares the model used to several other models). You go check your work for a while and then go back to the project you were working on before the trade came in.
11:30am - lunch at the desk
12:30pm - new trade comes in, a hedge fund wants to do a reverse repo on a stock.
12:35pm - trader whines about his sheet freezing up while pricing the particular stock repo vs the counterparty. you tell him it's because he has too much stuff open and running.
12:40pm - trade is priced and your desk wins the trade.
12:45pm - trader complains that the hedge ratio on the repo can't be right. You wonder why he thinks there's a ratio on the repo. . .
1:30pm - model validation comes back with the 'go-ahead' on the basket option trade (sometimes they come back within the day, for more complicated stuff it can take days).
1:40pm - the counterparty is notified of the trade price, but you know they won't get back to you till the next day.
2:00pm - another equity repo trade
3:00pm - bond markets close. This is important to you because some of the exotics you price can cross fx, fixed income, equity and credit all at once.
4:00pm - equity market closes
4:10pm - make sure all the marks are correct in the derivatives book and double check hedge assumptions
4:45pm - work on correlation matrix for one of the trades in the book
5:30pm - you're an equity guy, time to go home.
note: this is probably a fairly easy day as far as leaving at 5:30, but generally speaking the trade volume tends to be pretty light. There's an occasional "truly" exotic trade that takes a couple days to price. Lots of repo type deals or total return swaps with hedge funds. Technically as the quant you're not reponsible for the risk, but you are responsible for giving good fast prices.
Stats Quant:
6:30am - get up, shower
7:00am - get to the office, log onto relevant machines
7:10am - Check overnight diagnostics on machine trading algorithms being run overnight. Since you didn't get a phone-call waking you up (automated, of course) and telling you of an error, you don't expect to see anything abnormal. You don't need to check overnight pnl because it was e-mailed to you at 6am.
7:30am - open project being worked on. Usually a program in C++ or some research in R/S-plus. Begin programming.
8:20am - fixed income markets open, make sure machine run trading systems are not failing. You really don't have to do much here because you're supposed to get an e-mail and some bells/whistles go off when stuff breaks. Not to mention the electronic systems were running overnight. Some of the trading algorithms only run during liquid hours though.
8:30am - go back to your programming.
9:30am - equity markets open, you do the same drill you did with the fixed income markets.
9:40am - back to programming
10:20am - one of the trading systems throws an error. It froze itself, but you need to manually take it out of it's risk. You delve into the code to see what happened.
10:50am - you found the bug and fixed it. You would test it on the test servers, but the bug happens so infrequently that it wouldn't matter. You did test it internally. You plug it back in and go back to your original project.
11:20am - you go out to grab lunch with a couple colleagues. You decide to stay out for lunch today as opposed to bringing it back to the desk.
12:10pm - you return to your desk and return to coding.
2:50pm - the daily manual trading algorithms produce their results. You and your colleagues discuss the results and start making phone calls to put on the trades given by the daily algorithms. These often involve OTC derivatives, so you actually need to place the phone call to trade.
3:20pm - trades finalized.
3:30pm - daily quant round-table meeting. You and the other quants discuss any issues you've had with coding, any ideas you have for new trading ideas and papers you read overnight. The discussion flows like a classroom. The meeting ends with the new trading ideas that seem worth following being moved forward for a full write-up. Those that have already been written up and fully discussed today move into development phase and are assigned programmers. A paper is handed out for reading overnight.
5:00pm - after the meeting you and a colleague decide to play a quick game of chess.
5:20pm - you lost, again. . . that guy used to be a championship player.
5:30pm - you go back to your workstation to save everything down and make sure things are running.
6:00pm - the fixed income electronic markets open back up (they are 23 hour markets) to check that all the diagnostics are running. You go home as soon as everything checks out.
note: as a prop-side quant your day is somewhat less structured. That means you really need to be driven to do your research and develop new ideas on your own. It's like being a really well paid academic. You don't have others pushing you to do something right as much as you do on a sell-side desk. Typically you need more background for this sort of work too. Usually you see PhDs who did their dissertations in a relevant or exotic fields (exotic because they tend to bring ideas that are unique and methods that are different from the usual tools known to the finance world). You probably will need to be able to program your own stuff (most PhDs in technical fields learn sufficient programming).
Hope this helped. Feel free to e-mail with more questions.
Exotic Derivatives Quant:
5:45am - get up, shower
6:30am - be on train
7:00am - get to office
7:10am - deal with first trader complaint. A pricing module for knockout options on fx broke.
7:30am - morning call with traders, quants and sales people
7:45am - work on forward discount curve for dollar denominated assets.
8:20am - first trade of the day comes in. A European bank wants to price a equity index basket option. You start on the code immediately (VBA or C++, depending on the difficulty of the basket/option being priced and also depending on the bank from what I've heard).
9:00am - finished writing and debugging code. Go to your validating quant to check work. (Usually two quants will work on a given model at the same time. If both models get to the same answer within a certian tolerance, then the code is considered good).
9:20am - your code and validation code match up, code is sent to the model validation quants (usually yet another group that compares the model used to several other models). You go check your work for a while and then go back to the project you were working on before the trade came in.
11:30am - lunch at the desk
12:30pm - new trade comes in, a hedge fund wants to do a reverse repo on a stock.
12:35pm - trader whines about his sheet freezing up while pricing the particular stock repo vs the counterparty. you tell him it's because he has too much stuff open and running.
12:40pm - trade is priced and your desk wins the trade.
12:45pm - trader complains that the hedge ratio on the repo can't be right. You wonder why he thinks there's a ratio on the repo. . .
1:30pm - model validation comes back with the 'go-ahead' on the basket option trade (sometimes they come back within the day, for more complicated stuff it can take days).
1:40pm - the counterparty is notified of the trade price, but you know they won't get back to you till the next day.
2:00pm - another equity repo trade
3:00pm - bond markets close. This is important to you because some of the exotics you price can cross fx, fixed income, equity and credit all at once.
4:00pm - equity market closes
4:10pm - make sure all the marks are correct in the derivatives book and double check hedge assumptions
4:45pm - work on correlation matrix for one of the trades in the book
5:30pm - you're an equity guy, time to go home.
note: this is probably a fairly easy day as far as leaving at 5:30, but generally speaking the trade volume tends to be pretty light. There's an occasional "truly" exotic trade that takes a couple days to price. Lots of repo type deals or total return swaps with hedge funds. Technically as the quant you're not reponsible for the risk, but you are responsible for giving good fast prices.
Stats Quant:
6:30am - get up, shower
7:00am - get to the office, log onto relevant machines
7:10am - Check overnight diagnostics on machine trading algorithms being run overnight. Since you didn't get a phone-call waking you up (automated, of course) and telling you of an error, you don't expect to see anything abnormal. You don't need to check overnight pnl because it was e-mailed to you at 6am.
7:30am - open project being worked on. Usually a program in C++ or some research in R/S-plus. Begin programming.
8:20am - fixed income markets open, make sure machine run trading systems are not failing. You really don't have to do much here because you're supposed to get an e-mail and some bells/whistles go off when stuff breaks. Not to mention the electronic systems were running overnight. Some of the trading algorithms only run during liquid hours though.
8:30am - go back to your programming.
9:30am - equity markets open, you do the same drill you did with the fixed income markets.
9:40am - back to programming
10:20am - one of the trading systems throws an error. It froze itself, but you need to manually take it out of it's risk. You delve into the code to see what happened.
10:50am - you found the bug and fixed it. You would test it on the test servers, but the bug happens so infrequently that it wouldn't matter. You did test it internally. You plug it back in and go back to your original project.
11:20am - you go out to grab lunch with a couple colleagues. You decide to stay out for lunch today as opposed to bringing it back to the desk.
12:10pm - you return to your desk and return to coding.
2:50pm - the daily manual trading algorithms produce their results. You and your colleagues discuss the results and start making phone calls to put on the trades given by the daily algorithms. These often involve OTC derivatives, so you actually need to place the phone call to trade.
3:20pm - trades finalized.
3:30pm - daily quant round-table meeting. You and the other quants discuss any issues you've had with coding, any ideas you have for new trading ideas and papers you read overnight. The discussion flows like a classroom. The meeting ends with the new trading ideas that seem worth following being moved forward for a full write-up. Those that have already been written up and fully discussed today move into development phase and are assigned programmers. A paper is handed out for reading overnight.
5:00pm - after the meeting you and a colleague decide to play a quick game of chess.
5:20pm - you lost, again. . . that guy used to be a championship player.
5:30pm - you go back to your workstation to save everything down and make sure things are running.
6:00pm - the fixed income electronic markets open back up (they are 23 hour markets) to check that all the diagnostics are running. You go home as soon as everything checks out.
note: as a prop-side quant your day is somewhat less structured. That means you really need to be driven to do your research and develop new ideas on your own. It's like being a really well paid academic. You don't have others pushing you to do something right as much as you do on a sell-side desk. Typically you need more background for this sort of work too. Usually you see PhDs who did their dissertations in a relevant or exotic fields (exotic because they tend to bring ideas that are unique and methods that are different from the usual tools known to the finance world). You probably will need to be able to program your own stuff (most PhDs in technical fields learn sufficient programming).
Hope this helped. Feel free to e-mail with more questions.
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