The Trading Desk

1
The Trading Desk

• A theme of Ron Chernows House of Morgan is that
  the trend in the profitability of investment
  banks since the 1960s is toward trading
  activities - and away from relationships.
• A trading room / desk is commonly associated with
  the management of a large position (e.g., a
  commercial banks foreign exchange operations).

2
Trading Desk 2

• Braas and Bralver argue that the profitability of
  the dealership function is not in speculation.
• They do indicate that if a dealer can identify
  that the reason for a major move is lack of
  liquidity in the market, then taking a position
  in the face of such liquidity crises will be very
  profitable. The real issue is whether these are
  only obvious in retrospect!

3
Trading Desk 3

• BB also introduce the notion of financial
  engineering - by identifying customer needs and
  pricing relationships, an investment bank may be
  able to carve out a monopoly position (at least
  temporarily). In such situations the firm may
  profit by positioning (i.e., taking a long-term
  inventory stand).

4
Trading Desk 4

• From BB, p. 68-9
• Some traders argue that there is no such thing as
  a bid-offer spread in a transaction, that each
  trade is a bargain struck, and that the range
  between the bid and the offered prices is simply
  a negotiating framework within (or outside of)
  which the bargain is concluded.
• This calls to mind the notion that any
  transaction is an implicit bargain - but
  different markets either suppress or highlight
  this fact.

5
Trading Desk 5

• (Consider the role of the bid-ask spread in the
  bond market The dealer is suggesting a
  willingness to trade, and eliciting an offer.
• Similarly for the posted prices at the Tucson Gem
  and Mineral Show. But what would happen if you
  offered Safeway 90 of the posted price on milk?
  Why?)

6
Trading Desk 6

• In many markets, noticeably Foreign Exchange,
  most trade is interdealer. (Why?)
• BBs Figure 2 highlights the relationship
  between market power and ge of the bid-ask
  spread retained.

7
Trading Desk 7

• Convergence of relationships and transactions?
• The most successful Wall Street firms have long
  recognized that distributing and selling
  securities (or other financial instruments) to
  smaller dealers and to institutional customers
  not only keeps them better-informed than their
  competitors, but also is a stable source of
  earnings. (p. 69)
• For most trading rooms, then, sales is and will
  remain the principal source of consistent and
  stable revenue and profits. For many operations,
  trading and trading and sales are misnomers.
  The business should really be called

8
Trading Desk 8 (contd.)

• sales and trading, because much of what are
  called trading profits are really the result of
  a good customer base and the resulting flow of
  orders and information. (p. 71)

9
Relationships Transactions

• Ironically, technology is enabling transactions
  to lead to relationships.
• Consider my Safeway Club Card, or internet
  vendors customer databases. (Although an
  important question is whether the internet vendor
  can internalize benefits from this relationship.
• Example Amazon.Com informed my son of a new book
  by a favorite author - but since theyve raised
  their pricing, hell buy it elsewhere.)