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
 Three Questions
• Experience with derivatives?
• What would you like to get out of today?
• Current topic of interest?
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
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
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
About US Bank
 5th largest bank in the country – $308B in assets
 Relatively light user of derivatives
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
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)
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
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
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
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
Systems, Tools & Information Resources
 Derivative Valuation Model
 Bloomberg
 Reuters
 SNL
 Financial Calculator (TI BAII Plus)
 Internal Operations System
 Investment Banks
• Sales people
• Websites
Types of Customer Derivatives
 Interest Rate Swaps
 Caps/Floors/Collars
 Swaptions
 Treasury Locks
 Risk Participations
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
Interest Rate Swap
Customer Interest Rate Swap
Customer
 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
Counterparty
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
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
Wall Street Counterparties
 Bank of America
 HSBC
 Bank of Montreal
 JP Morgan
 Barclays
 Morgan Stanley
 BNP Paribas
 Royal Bank of Canada
 Citigroup
 Royal Bank of Scotland
 Credit Suisse
 UBS
 Deutsche Bank
 Wells Fargo
 Goldman Sachs
Derivative Position Skill Set
 Bond math
 Knowledge of fixed income markets
 Keep up on current events
 Working knowledge of accounting
 Interpersonal skills
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
Q&A
 Questions?
1 am, Monday, September 15, 2008
 What happened?
September 15, 2008
 Just before 1 am, Lehman Brothers files for
bankruptcy
• Largest bankruptcy filing in US history
• $639 billion in assets
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?
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
Next Step
 Are we done with our Lehman trades?
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
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?
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
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?
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
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?
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
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
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
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
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
Q&A
 Additional questions?