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A Day in the Life of a… Derivative Trader

A Day in the Life of a… Derivative Trader. Joe Tessmer, CFA. March 11, 2011. Agenda. 8:00-8:30 – Introductions 8:30-9:30 – Day in the Life of… 9:30-9:40 – Break 9:40-10:30 – Current Derivative Topics 10:30-11:00 – Q&A. Introductions. Company / College Current position / Major

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A Day in the Life of a… Derivative Trader

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  1. A Day in the Life of a…Derivative Trader Joe Tessmer, CFA March 11, 2011

  2. Agenda • 8:00-8:30 – Introductions • 8:30-9:30 – Day in the Life of… • 9:30-9:40 – Break • 9:40-10:30 – Current Derivative Topics • 10:30-11:00 – Q&A

  3. Introductions • Company / College • Current position / Major • Three Questions • Experience with derivatives? • What would you like to get out of today? • Current topic of interest?

  4. Education • Graduated from Roseville Area High School in 2000 • Graduated from Boston University Undergraduate School of Management in 2004 (Finance/Accounting) • Received CFA charter October 2008 • Recently engaged with plan for a 2012 wedding

  5. Internships • Summer 2001: Fairview-University Medical Center • Finance Analyst • Summer 2002: Classic Design Services • Accounting / Finance projects • Summer 2003: Neuberger Berman • Financial Analyst in Corporate Finance Group

  6. Career Path • July 2004-July 2005: Classic Design Services • Financial Analyst / Accounting Manager • August 2005-January 2006: US Bank • Derivative confirmations • Contract employee for first three months • January 2006-August 2006: US Bank • Analyst on Municipal Tender Option Bond program • August 2006-Today: US Bank • Derivative/Funding desk

  7. About US Bank • 5th largest bank in the country – $308B in assets • Relatively light user of derivatives

  8. US Bank - Treasury Department • Department Structure • Derivatives & Funding • Investment Portfolio • Asset/Liability Management • Economic Capital / Quantitative • Capital / Liquidity • Bank Support / Securitization / Equity Investments • Money Center (Fixed Income Sales) • Treasury Operations • Treasury Systems

  9. Derivatives & Funding Desk • Head of Derivatives & Funding • 5 Traders • 2 Derivatives & Term Funding Traders (Joe) • 2 Overnight Funding Traders • 1 “Swing Trader”: Derivatives, Term Funding, & Backup Overnight Trader • 1 Middle Office Analyst (reports to Joe)

  10. Derivatives & Funding Trader • Derivatives • Customer trades & related hedging • Balance sheet hedging • Term Funding • USB internal cost of funds • Bank notes / Medium term notes / FHLB Advances • Capital transactions • Hybrid capital / Preferred stock • Share Repurchase Program

  11. US Bank – Provider & End User of Derivatives • Customer Activity • Interest Rate Derivatives • Foreign Exchange • Balance Sheet Hedging • Interest Rate Derivatives • Foreign Exchange • Credit Derivatives • Equity Derivatives • Funding Transactions with Embedded Derivatives

  12. Typical Day • 7:00-8:30: News/Economic releases/Email • 8:30-End of day: Derivative trades/Funding transactions/Reporting/Projects/? • Generally leave office between 6-6:30 pm

  13. Typical Daily Activities • Talk on the phone • Keep up on email • Receive 500+ emails per day; mostly market commentary • Meetings/Conferences Calls • Internal: Projects; Monthly meetings • External: Investment bankers • Customer Derivative Trades • Monitor rates & equity markets • Lunch at desk • Instant messaging • Watch TV

  14. Systems, Tools & Information Resources • Derivative Valuation Model • Bloomberg • Reuters • SNL • Financial Calculator (TI BAII Plus) • Internal Operations System • Investment Banks • Sales people • Websites

  15. Types of Customer Derivatives • Interest Rate Swaps • Caps/Floors/Collars • Swaptions • Treasury Locks • Risk Participations

  16. London Interbank Offer Rate (LIBOR) • Indicative rate of where banks can borrow USD for various terms in the London interbank market • Currently a survey of 16 banks (soon to be 20) • Drop high and low quartile • Average middle 8 submissions • Used as the floating index on swaps and mortgages • Primary inputs for deriving swap curve • Not based on actual trades

  17. Interest Rate Swap

  18. Customer Interest Rate Swap • Customer takes out floating rate loan with U.S. Bank • Customer wants to hedge against rising interest rates • U.S. Bank enters into a “receive fix” swap with customer • U.S. Bank simultaneously enters into “pay fix” swap w/ street Final outcome: • U.S. Bank is hedged and has made 25 bps • Customer has a locked in fixed rate at 7% (5% + 2%) SWAP HEDGE LOAN Swap Counterparty Customer 4.75% 5.00% LIBOR LIBOR LIBOR + 2.00%

  19. Credit Default Swap • Protection against default of a reference entity • Buyer of protection makes periodic payments • Seller of protection agrees to make buyer whole if the reference entity has a “Credit Event” • Credit Event • Bankruptcy • Failure to Pay

  20. Total Return Swap • Buyer receives the total return of an underlying instrument (i.e. equity indices, individual stocks) • Buyer pays Libor +/- Spread • Synthetic way of going long/short a security • More efficient way of hedging equity-based risk • USB uses to hedge deferred compensation program

  21. Wall Street Counterparties • Bank of America • Bank of Montreal • Barclays • BNP Paribas • Citigroup • Credit Suisse • Deutsche Bank • Goldman Sachs • HSBC • JP Morgan • Morgan Stanley • Royal Bank of Canada • Royal Bank of Scotland • UBS • Wells Fargo

  22. Derivative Position Skill Set • Bond math • Knowledge of fixed income markets • Keep up on current events • Working knowledge of accounting • Interpersonal skills

  23. Finding a Position in Derivatives • Understand finance basics • Present value concepts • Understand bond math • Conversational knowledge of different types of derivatives • Look for related positions • Middle office, back office • Emphasize ability to learn new things

  24. Q & A • Questions?

  25. 1 am, Monday, September 15, 2008 • What happened?

  26. September 15, 2008 • Just before 1 am, Lehman Brothers files for bankruptcy • Largest bankruptcy filing in US history • $639 billion in assets

  27. Lehman Bankruptcy - The Morning After • Scenario • Your firm has 72 trades with Lehman’s derivative unit, Lehman Brothers Special Financing (LBSF) • 6 am Monday Morning • What do you do now?

  28. Default Notice • Lehman Brothers Holdings bankruptcy triggers event of default under ISDA • USB’s counsel hand delivers a default notice to Lehman’s headquarters on September 16 • Default notice effectively terminates all transactions with LBSF

  29. Next Step • Are we done with our Lehman trades?

  30. Replacement Hedges – Market Quotation • Under the terms of the ISDA, Early Termination values are determined by a Market Quotation procedure • At least 3 market-makers need to value trades simultaneously • 72 trades * 3 Market-makers = 216 trade indications

  31. Replacement Trades • 13 Hedging Swaps • 36 Libor Customer Swaps • 21 Non-standard Customer Swaps • 2 Loan Credit Default Swaps • 1 Cross Currency Swap • What do we hedge first?

  32. Replacement Trades • Combine market quotation with bid process • Majority of Lehman counterparties following same process • Some dealers don’t trade certain swaps • SIFMA (Municipal index) • Prime • Commercial Paper • Libor Averaging

  33. Lehman Post Mortem • Trade execution completed Wednesday, September 17 (3 days start to finish) • Loss of hedge accounting treatment • Bankruptcy resulted in derivative losses of 12MM for USB • Lehman bankruptcy claims trading around $0.40/dollar in secondary market • What can we do to make sure this does not happen again?

  34. Dodd-Frank Financial Reform Bill • Combination of Lehman and AIG lead to additional regulation of OTC derivative market • Title VI – Volcker Rule • Title VII – Derivative Reform • New regulators • Swaps: CFTC • Security-based swaps: SEC

  35. Title VI - Volcker Rule • Prohibits an insured depository institution from: • Engaging in “proprietary trading” • Acquiring or retaining an interest in a hedge fund or private equity fund • How do we define proprietary trading?

  36. Title VII - Derivative Reform • Market participants that meet specific criteria will be classified as swap dealers or major swap participants • Must register with CFTC (swaps) or SEC (security-based swaps) • Trades must be cleared through a Central Counterparty Clearing House (CCP) • End users exempted from clearing requirement

  37. Swap Execution Facility • If the product is offered on a platform, a trade must be executed on a Swap Execution Facility (SEF) • Request for Quote vs. Central Order Book • Over the phone trading not allowed for SEF eligible trades • Block trade exemption • Additional capital and margin requirements for non-cleared trades

  38. Central Clearing Model • Current Model • USB calls swap dealer and executes over the phone • All payments sent between USB and dealer • Central Clearing Model • USB executes trade through SEF with swap dealer • CCP steps in between to become the counterparty to both parties of the trade • All payments run through CCP

  39. Real Time Reporting & Record Keeping • All trades must be reported to a Swap Data Repository (SDR) as soon as technologically practicable • Delayed reporting for block trades • Mandated electronic confirmations • Complete records must be kept for 5 years after maturity

  40. Title VII - Derivative Reform • All rules must be released by July 2011 (1 year after Dodd-Frank signed into law) • Current law says that implementation must be completed by September 2011 • Most likely scenario has implementation required in stages over the next 12-18 months

  41. Q & A • Additional questions?

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