Guide to proprietary trading in financial instruments


Proprietary trading is carried out by banks trading in financial instruments (cash, securities, foreign currencies, precious metals or derivatives).

Proprietary trading seeks to profit in order to improve the results obtained from the customer business.

It can also be done indirectly from the banking book if the fixed asset attributable to customer transactions is not traded later than the close of business (ie, liquidated ).

For proprietary trading purposes, credit institutions use the information and tools that are available for these purposes.

In addition, it can contribute to the human and material trade capacity which will be utilized later to cover the high fixed costs in these areas.

Legal Issues

To provide short-term proprietary trading success requires the assignment of the proprietary trading book directly on a transaction.

Proprietary trading positions are those positions held intentionally for short-term resale or where the intention is to move from current or soon-to-be expected price differences between the buying and the selling price or any other price and interest rate variations.”

Operating activities involve the purchase or sale of securities, foreign currencies, precious metals or derivatives. This can be done tactically through arbitrage or speculation.

It entails taking both short-term and long- term strategic positions. The course maintenance is a part of proprietary trading, even if it was contractually agreed with the issuer of securities.

It is not without risk. In volatile markets, these risks increase, necessitating the use of risk mitigation techniques, and includes clearing and hedging.

Understanding the risks in proprietary trading

The risks consist primarily of market and liquidity risks. From the perspective of the banks it may be caused by unexpected market risks, adverse changes in interest rates, exchange rates and other prices.

Other not to be underestimated risks are operational risks (such as the failure of data processing systems ) and legal risks (such as unpredictable changes in laws ) .

The dimensions of market risk is measured using the value-at-risk (VaR) method. The value-at-risk of the trading book is the upper loss limit, ( eg 99 % ) is not exceeded at a given holding period with high probability.

Global proprietary trading requires multiple inventory and sequential trading a dynamic risk management process with continuous , decentralized organization considered monitoring and controlling the risks incurred .

How to limit proprietary trading risks

To limit the institutional proprietary trading risks, dealer limits are given, which consist of the following sub-limits :

Overnight limit is the limit of the open position at the end of the working day. It corresponds to the position limit. Depending on the assessment of market risk, the calculation of risk per trader in a scenario analysis is defined.

Intraday Limit is set depending on the qualification and position of the dealer and the market liquidity of the traded instrument. The limit can also be dependent on whether a bank holds a market-making function or not.

Once the specified limit is reached, a trader has the right to request to name a price at which the bank is willing to enter into commercial amounts.

Stop loss limit

Limits the maximum loss that the bank is willing to take on a position. If this limit is reached, the dealer must close his position, even if he still has free position limit. It can also be moved to the overnight limit .

Maturity mismatch limit

This limits the open risks in the individual terms that can be specified in addition to the overall position limit yet.

Risk Management is responsible for establishing the limit, the development and monitoring of internal bank proprietary trading strategies.

Among the supporting functions include the development and operation of information systems, detection / monitoring of business transactions and the monitoring of regulatory requirements .

The user can specify in proprietary trading between three different forms of organization.

The simplest way of proprietary trading offers the “Single Inventory Model”.

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