Basic, lesson 1 of 3
How a markets desk makes money
A desk earns mostly from clients: the bid offer it charges, the fees and financing it provides, and how well it manages the inventory clients leave behind. Directional bets are a smaller share than outsiders assume.
9 min, 3 checks
1Where the revenue comes from
A bank's markets division sits between clients who want to buy and clients who want to sell. It rarely finds both at the same moment, so it uses its own balance sheet to take the other side and holds the position until it can offload or hedge it. The price of that service is the bid offer spread.
| Line | What it is | Example |
|---|---|---|
| Bid offer | Buy at the bid, sell at the offer, keep the gap | Quote a bond 99.50 / 99.60 and trade both sides |
| Commissions | A fee for executing a client order without taking risk | Working a stock order through the close for a few cents a share |
| Financing | Lending cash or securities against collateral | Repo, prime brokerage, stock lending |
| Structuring | Building a tailored product and hedging it | A note that pays if an index stays in a range |
| Inventory P&L | Gains or losses on positions held between client trades | A bond bought from a client that falls before it is sold |
Worked example
Earning the spread
- 1You quote a corporate bond at 99.50 bid, 99.60 offered.
- 2A pension fund sells you 10 million at 99.50.
- 3An hour later a hedge fund buys 10 million from you at 99.60.
- 4Gain: 0.10 points on 10 million face = 0.10 / 100 x 10,000,000 = 10,000 dollars.
10,000 dollars for standing in the middle for an hour, as long as the price did not move against you in between. That condition is the whole job.
Check 1
You quote 101.20 / 101.30 on a bond, buy 5 million on your bid, and sell 5 million on your offer before the price moves. What did you make, in dollars?
2Principal and agency
On a principal trade the bank becomes the buyer or seller and owns the risk until it unwinds. On an agency trade the bank only executes for the client, at whatever price the market gives, and charges a commission. Principal pays more and can lose money; agency pays less and cannot lose on price.
Check 2
A client sends an order to buy 200,000 shares at the day's volume weighted average price, for a commission. Who carries the risk if the stock rallies during the day?
3Reading a day's P&L
Desks split each day's P&L so they can see what actually earned money. A common split is client P&L (the edge captured against mid when the trade was done), carry (what positions earn or cost to hold, such as coupon minus financing), and market moves (the change in the value of inventory).
Worked example
One position, three lines
- 1You buy 20 million of a bond from a client at 99.50 when mid is 99.55. Client P&L: 0.05 / 100 x 20,000,000 = +10,000.
- 2Overnight the bond earns 1,500 more in coupon than it costs to finance. Carry: +1,500.
- 3Next morning mid falls to 99.40, 0.15 below where you marked it. Market P&L: -0.15 / 100 x 20,000,000 = -30,000.
- 4Total: 10,000 + 1,500 - 30,000 = -18,500.
The trade was a good client trade and a bad position. The split tells the desk head which problem to fix: pricing or hedging.
Check 3
Client P&L is +25,000, carry is -2,000, and market P&L on inventory is -8,000. What is the day's total P&L?
Terms in this lesson: Repo, Hedging.
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