This post is strictly for those who work in Finance domain.
Someone in a common forum asking for brief information on “Trade
Life Cycle”, feel like helping her and to others who may be in need, so spend
few hours late night to write down the below. It’s 4 in the morning, weekend n
badminton awaiting. Trade Life Cycle such a huge topic where few days not
enough to discuss, finally managed to put it down in 3 pages.
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Hi,
I am going to correlate Trade (aka Deal) Life Cycle
with a real life example. Throughout this explanation assume that you are “Owner
of Electronics Shop”, I will explain “Trade Life Cycle” from your perspective.
FRONT OFFICE
A customer (assume me)want to buy Television, searching for
better shop on the street, when I am near your shop, Few people invite me in, making me comfortable in the shop,
finding my requirements, showing different Tv’s etc.. I keep asking for price
by changing my inputs like TV model, screen size, resolution etc, Obviously
your people will give me different price based on my inputs.
---------------- FINDING VALUE OF TV (UNDERLYING) BY VARYING
MY INPUTS IS PRICING. Few people
involved here are SALES PEOPLE (Who just arrange transaction with some
margin) or TRADERS who work for your shop
Now I have finalized my TV, informed my choice, your people will
enter the transaction in your system (TRADING SYSTEM). ----- This is DEAL
BOOKING
MIDDLE OFIFCE
You will arrange your people such that one person will give price,
another senior verify it before final confirmation, this is to avoid any misuse
either by chance or choice. People arrangement process here is “Validation”
process. (If you don’t have validation and if sales person is my friend, I may
get IPAD for 15 Dollars).
Quite often you will hear something called 4 EYES
Principle, means one person (2 eyes) will give the price and another person
(another 2 eyes) will verify/validate/Reject. This verification can go up to
many levels depending on the amount or complexity of the transaction.
(Here your people need some reports for better risk
management and validation, like ‘average price selling for different TV’s’,’
today’s market rate’,’ customer transaction history’ etc..) – ALL THIS
PROCESS IS RISK MEASUREMENT AND MANAGEMENT
BACK OFFICE
After your people validate the deal, they confirm to me by
giving me automated “Bill(Confirmation, some times invoice also together)” in paper form- This process
is called “Confirmations Generation(HTML,ISDA,SWIFT)”
I will verify everything mentioned in the invoice and will acknowledge
the transaction (This case just nodding my head). After receiving my acknowledgement,
then only this transaction is fully confirmed.
I will pay money and you will deliver TV set. (Delivery
Vs Payment). -Payment process.
This is not the end of “Transaction”. Your shop
have exchange/replace/return policies as well right?
Market Operations:
I went home and no one at home likes the TV, so I come back to
your shop and wanted to “CANCEL” the transaction. (Or)
I want to give TV back and buy another TV --- CANCEL AND
REISSUE (Or)
After few days, I have technical problems with TV set – RESTRUCTURE
(Or)
I want to sell it off to you after some time – EARLY TERMINATION
(Or)
Warranty is reached and you don’t want to entertain any
activities related to this TV –EXPIRY (Or)
Suppose if I buy many other items along with TV and sold
some of old stuff, you will net all of them and will give me final amount to
pay, instead of individual bills- NETTING
Depending on the underlying transaction, you will have many
market operations
OTHER
IMPORTANT MODULES OF DEAL LIFE CYCLE(OR SYSTEM LIFE CYCLE)
Accounting:
Accounting is ledger maintaining all the payments happening (or
going to happen [Mark to Market]) by department wise or for entire shop
(Entity) and it comes as part of back office.
Your business has grown and you want to manage Tv’s accounts
separately, TV department is one Accounting Section , like that you may
have multiple accounting sections for different units.
Fixings and Payments:
Suppose if you sell TV in installments, amount to be
received for every installment is dynamic and is based on the interest rate of
that month, so every month you have to FIX the interest for that deal,
so that corresponding payment will be generated. Fixing is part
of back office process.
Market Data:
When I come to the shop for TV, your people giving me price
for TV. You sell so many goods and every day price may change for all of them.
No one come and by hard price every day morning right? , also for fixings etc…you
have to get data from somewhere before your shop opens, This is what called as Market
Data (Reuters and Bloomberg are the famous market data providers in finance)
Profit and Loss:
You don’t sell TV for fun right? You want to make some money
out of it. You would have bought TV somewhere at least few days before, it means
1. You
made investment,
2. Interest
on the investment,
3. Inventory
cost
4. Profit
for you
Everything you will include while selling TV. PnL,
its nothing but subtracting your total cost from the selling price.----------
Front office
Simulation:
If I have to say “Simulation” in technical terms, it’s like “Group
by” column of SQL queries n running “What If” scenarios on your
business. Some of the outputs of simulation are “PnL of TV Dept”, “PnL
of Sony Brand”, “what will happen if TV prices go down by 5%”, “if
you have loss which Hedge deal can cover your loss “etc,so on……., Recap “Monte
Carlo Simulation” of college days.—Front office activity
Reports:
Your frequent customer may want a report all the
transactions made in the last one year. You need reports to see the PnL of different
sub sections or Entire shop etc. You need reports for income tax , for
auditors, for risk management etc…--Mainly for Middle Office purpose.
Clearing and Settlement:
If you hire some third party organization to collect your
money from your customers and to pay your money on behalf of you. ---- It’s a Back
office process
Nostro Management:
Every month you need to have funds to pay salaries, to
maintain your shop, to purchase goods, to maintain inventory. TREASURY
department make sure that you have enough funds in your bank account (NOSTRO), keep
filling NOSTRO accounts to have enough money always in your bank accounts.
End Of The Day
For today end of the day is after 24 hours, similarly
trading system also has similar process. End of the day for trading
system means, preparing system for next working day. Similar to rearranging all
your shop after you close your business and making sure that market data etc…available
before customers comes to your shop next day ( Changing system dates and
copying market data to the next day etc….).
So Deal or Trade in the above entire episode is “SELLING
TV” from your perspective, from my perspective “BUYING TV”. Its very
important to understand the context while getting requirements or while
speaking, meaning completely changes depending on the context. While working on
a trading system, always look at the information in the system from “BANK’S
PERSPECTVE”.
Straight Through
Processing
Purpose of STP is reducing manual intervention and increase
the automation. Starting from the entering the deal in the system till its
expiry, we can automate many steps of life cycle using workflow managers .
Assume that you are have multiple shops in the same city
then expanded to another city, state wide, country wide and international
company. Now you have 1000’s of shops worldwide and you have to maintain all
the transactions happening in your shop. That’s where different Trading systems
come into picture to automate Deal Life Cycle, to Calculate risk, to put limit
checks make sure that you never encounter loss.
Understand basic trade life cycle, you can ask me any
questions of any complexity for any hybrid product in any area of deal life
cycle.
DEAL LIFE CYCLE PROCESS MAY
VARY BASED ON THE TYPE OF PRODCUT.
