The selling and buying of financial products and instruments are known as trade or deal. But, the process of completing a trade is not so simple. From the moment a trade is initiated through an order to when it is settled, the steps and stages involved in the process together form a trade life cycle. It is important for financial institutions like hedge funds, investment banks, pension funds, etc., to maintain their trade life cycle.
Considerable planning and subsequent follow-up are required to complete a trade. This article will attempt to break down the entire trade life cycle and give an account of each step. Read on to learn in detail.
Why is a trade life cycle important in investment banking?
Trades involving financial products are worth a lot. Hence, even a small mistake in the steps can cause either party to lose a lot of money. Inefficient management can nullify a trade. Thus, financial companies that trade frequently need to keep track of the trade life cycle.
If you are aiming for a career in investment banking, then apart from foreign exchange and derivatives markets, an in-depth understanding of the trade life cycle can give you the necessary professional edge to succeed.
Stages in a trade life cycle
Depending on different types of trades, there can be some different steps in the trade life cycle. It can also vary from institute to institute. However, when talking about the stages of a trade life cycle in the context of investment banking, the main stages involved are:
In investment banking, the trade begins with preparing the deal. The institution ensures that the trade abides by local laws and that all the legal documents related to the case are in order. Evaluation of counterparty credit risk, management of risk and collateral collection are also part of the process.
Beginning and execution of the trade
After the preparation for the trade is done, both parties initiate the trade process. Following negotiations, the parties reach an understanding and the counterparty places an order with the institution which executes the trade. A trade confirmation is then sent to the client as proof of the deal.
The process of trade capture involves booking the trade into the various office systems of the institutions. It includes recording the trade in both the front, middle and back office systems. The main details usually recorded from the trade are price, quantity, underlying assets, the date and time of the trade, etc.
Trade validation and confirmation
The back office system evaluates the trade before the trade settlement is confirmed. The limits and risks of the valuation are also checked in this stage. More details are added to the records while the professionals give a final check to identify any lingering problems or loopholes in the records.
If two institutes are working for different clients during an investment process, then all the details are verified and confirmed by both parties.
After every detail is confirmed and assessed by all the parties involved, they can finally move on to the settlement process. It involves the exchange of security and money; usually, the back office staff is in charge of overseeing a smooth and fair transaction.
Based on the method, there are two types of settlement:
- Delivery-versus-payment (DVP) - Cash and securities are exchanged simultaneously in this case.
- Free-of-payment (FOP) - Here, securities and cash are delivered separately. Usually, in this case, the security is delivered before the payment is made. It is a risky affair since the counterparty may retract.
A trade settlement, thus, should be done within 1-3 days of the trade date. This minimises associated risks.
Sometimes trades are terminated or expire before maturity. The termination of a trade can be a long process.
Risk management at the end of a trade life cycle is extremely crucial for both the client and the institute. Measuring the profits and losses of the transaction, assessing the counterparty's credit risk, preparing reports and managing trade reconciliation are all part of risk management after trade settlement.
It is important for any finance professional to know the different stages of a trade life cycle and why managing it is so important. If you want to build a career in investment banking, then learning the ins and outs of the trade life cycle will prove valuable. Thankfully, the Imarticus Certified Investment Banking Operations Professionals programme or CIBOP, is there to help you build your investment banking career.
If you are a finance graduate with some work experience under your belt, then this course is perfect for you. You can avail yourself online live classes, experiential learning and career support. The course also comes with job assistance. So, boost your investment banking career with the Imarticus CIBOP course.