Template:Equity derivative charging: Difference between revisions
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Remember our theory of the game, [[synthetic PB]] ninjas: ''[[synthetic PB]] is just [[margin lending]] done with swaps''. That should offer some clues about how clients ''pay'' for it. The economics are the same. | Remember our theory of the game, [[synthetic PB]] ninjas: ''[[synthetic PB]] is just [[margin lending]] done with swaps''. That should offer some clues about how clients ''pay'' for it. The economics are the same. This is about the economic cost of entering margin loans, not the economic exposure you have to the stock you have bought. Though that does come into it. | ||
===Costing of physical [[prime brokerage]]=== | |||
In a physical [[margin loan]] — representing a ''[[long]]'' equity position — the client expects two types of cost: | In a physical [[margin loan]] — representing a ''[[long]]'' equity position — the client expects two types of cost: | ||
*'''[[Financing]]''': The financing costs it will incur from its prime broker in borrowing the money it needs to buy the stock, and | *'''[[Financing]]''': The financing costs it will incur from its prime broker in borrowing the money it needs to buy the stock, and | ||
*'''[[Commission]]''': The [[brokerage]] [[commission]]s it will incur from its equity broker in buying (and when it is ready to, selling again) the stock. | *'''[[Commission]]''': The [[brokerage]] [[commission]]s it will incur from its equity broker in buying (and when it is ready to, selling again) the stock. | ||
To offset its costs, the [[prime broker]] can [[rehypothecate]] the stock, which it holds in custody for the client. Now when it does so, the [[PB]] does not take ''[[price risk]]'' to the stock: remember; it does not have a directional view on the stock. So it will not sell the stock outright, but more likely will use it as collateral in the market, to raise cash (under a [[repo]]) or high-quality assets (under a stock loan). If the stock increases in value, happy days for all concerned: the [[PB]] will receive more cash, and at the limit may reach its rehypothecation limit and have to return some of the rehypothecated stock to the client. If the stock declines in value, the [[PB]] will be able to raise less cash against it, but will be able to call for more margin from the client. | |||
In a ''[[short]]'' position on margin, the client expects the following costs: | In a ''[[short]]'' position on margin, the client expects the following costs: | ||
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In either case the client has something it can offer the prime broker to offset its internal funding costs: for a long margin loan, the stock it has bought, which the PB can rehypothecate; for a short position, the proceeds of sale of the stock, which it banks with the PB. | In either case the client has something it can offer the prime broker to offset its internal funding costs: for a long margin loan, the stock it has bought, which the PB can rehypothecate; for a short position, the proceeds of sale of the stock, which it banks with the PB. | ||
===Costing of [[synthetic prime brokerage]]=== | |||
Under an [[equity swap]], the client never actually buys the stock, but it puts on a {{isdaprov|Transaction}} with its prime broker that replicates the economics of doing so, on margin: | |||
===Long equity swap=== | |||
===Short equity swap=== | |||
Revision as of 15:19, 28 September 2020
Remember our theory of the game, synthetic PB ninjas: synthetic PB is just margin lending done with swaps. That should offer some clues about how clients pay for it. The economics are the same. This is about the economic cost of entering margin loans, not the economic exposure you have to the stock you have bought. Though that does come into it.
Costing of physical prime brokerage
In a physical margin loan — representing a long equity position — the client expects two types of cost:
- Financing: The financing costs it will incur from its prime broker in borrowing the money it needs to buy the stock, and
- Commission: The brokerage commissions it will incur from its equity broker in buying (and when it is ready to, selling again) the stock.
To offset its costs, the prime broker can rehypothecate the stock, which it holds in custody for the client. Now when it does so, the PB does not take price risk to the stock: remember; it does not have a directional view on the stock. So it will not sell the stock outright, but more likely will use it as collateral in the market, to raise cash (under a repo) or high-quality assets (under a stock loan). If the stock increases in value, happy days for all concerned: the PB will receive more cash, and at the limit may reach its rehypothecation limit and have to return some of the rehypothecated stock to the client. If the stock declines in value, the PB will be able to raise less cash against it, but will be able to call for more margin from the client.
In a short position on margin, the client expects the following costs:
- Financing: The financing costs it will incur from its prime broker in borrowing the security it wants to short, and
- Commission: The brokerage commissions it will incur from its equity broker in selling (and when it is ready to, buying back) the stock it has borrowed.
In either case the client has something it can offer the prime broker to offset its internal funding costs: for a long margin loan, the stock it has bought, which the PB can rehypothecate; for a short position, the proceeds of sale of the stock, which it banks with the PB.
Costing of synthetic prime brokerage
Under an equity swap, the client never actually buys the stock, but it puts on a Transaction with its prime broker that replicates the economics of doing so, on margin: