Case 4: Managing a Trading Desk

Question 1:

You finally got your break. You are now the head of gold trading for a major bank. It has been a good year and your traders have done well. Your book of business is up sharply and now that it is September you are trying to find a way to motivate your traders, who seem to be very risk adverse. By the way you are a European bank governed by EU bonus rules for regulated banks. The gold market has some volatility so you would like your traders involved. Again, they seem very risk adverse. Profits targets have been exceeded by 100% so you know they are good traders and the markets are ripe for their style of business. You are wondering why you cannot get interest from your traders. Indeed, many are using sick days to avoid coming to the office. Positons are being closed.

You ask an old hand in the trading room what is wrong. He laughs and says vega risk is too high for the individual trader under the new EU bonus rules. They are all looking to work for an American Bank in the Middle East next year. What does he mean?

Question 2: It is now October and since you are the new American hired to manage the oil desk you observe that your traders are taking wild risks. They seem to be much more than you would have expected. Why are they taking such risks? You ask an old hand in the trading room why. He laughs at you and says that it is October and profits have been below expectations for the year and remember this is a European firm. What does he mean?

Question 3:

One of your counterparties with whom you are trading is a closely held firm shares concentrated in a few wealthy families and banks -- that trades oil and oil derivatives. They are a global player and widely recognized as a part of the international firm as being innovative. Trading with them based on ISDA documentation is always on a bid offer basis. As a trading desk of a major company you show a bid and an offer on a derivative contract up to one year linked to oil. Knowing the counterpartys business, you would expect them to be about 40% hitting the bid and 60% hitting the offer on average with all their counterparties in combination. Timing is random, so it is difficult to know when they are doing what side; as such you have never been able to play them so you offer a normal standard bid offer spread. Lately however you have noticed a pattern. They are always hitting the bid side. You move the bid offer based on this information and the same things happen. What could be going on? You have a guess of what is happening. You go to your boss and tell him that based on your observation the firm is broke. Explain your logic. Your boss, who is a credit guy, says you are crazy. Who is right? Why?