Could some one please describe the operating mechanics behind interbank brokers. For example, do they risk their own capital when execute trades between banks? Also, as an example, how do they charge commission on a trade? Specifically, if I trade a convertible bond, the bid-ask spread is usually 1/2 point and they charge 5 cents per share of stock. Do the interbanks (GFI, Cantor etc..) charge the same amount to banks?

"do they risk their own capital when execute trades between banks?"Yes, meaning the take the execution risk on the trade. If the trade has been agreed and there's a fuck up in the execution they wear it, they don't pass it on to the client (that's what they're paid for)"how do they charge commission on a trade?"It varies, usually it is in basis points. It might change from player to player (ex: markets makers vs banks) and it is not directly related to the bid/ask spread you see in the mkt.

The amount charged by brokers varies a lot, and includes fixed or capped annual fees. Thus your trade may incur no charges at all.A common charge aimed at some IDBs who shall remain nameless is that the prices on screens are actually from the brokers themselves. As for fuckups, RFMontraz is right for some markets, but not others, some markets apportion the cost of soritng it out to the firm that screwed up. As you can imagine this is not a pain free process.

"Specifically, if I trade a convertible bond, the bid-ask spread is usually 1/2 point and they charge 5 cents per share of stock. Do the interbanks (GFI, Cantor etc..) charge the same amount to banks?"I may be slightly out of date, but the CB bookies used to charge an eighth. This is payable by the party that hits the offer or lifts the bid; the party that shows the offer or bid is not charged anything.

Thanks for your help. I'm still unsure of how interbanks charge for their trades. As a buyside trader, this is important since it it all about knowing how much a broker payed for its bonds. For example, if ML, GS or another bank buys (hits a bid) a convertible bond on a 50 delta from an interbank broker (GFI, Cantor, etc...), how much do they charge ML, GS, etc.. for the bond and stock transaction?

As i know it brokers usually don't charge on the stock transaction when you trade a convertible with a delta.The brokerage fee and how it is paid depends on the broker. In the most cases it is calculated in the cb price (if you settle against the broker). Sometimes they will send you a bill.If you pay 2, 5 or 12.5 BPS that depends on the broker (and you).

kulmoedeeFirst of all "interbank" is a term reserved for fx and interest rate markets. I have never heard it used in the CB market. The people who you refer to as "interbanks" are known formally as Inter Dealer Brokers, less formally as IDBs and colloquially as "bookies". Second, when a trader buys that is either because "his bid has been hit" or because "he has lifted an offer", it is not because he has "hit a bid".Third, the IDB charges a commission on the CBs but (as equityvsdebt correctly says) not on the shares. As I explained previously, the commission is paid by the bank that lifts the offer or hits the bid. No commission is paid by the bank that originally placed the bid or offer.Here's a simple example:Bank A to IDB: "101.25 bid XYZ": translation "I would be willing to pay 101.25% of face value for a yet-to-be-determined number of XYZ CBs.IDB then calls through to all other client banks: "XYZ 101.25 bid"Bank B to IDB: "half offered": translation: "I would be willing to sell a yet-to-be-determined number of XYZ CBs at a price of 101.5"IDB to Bank A: "half offer against your bid". Note: IDB does not show this offer to other banks until Bank A has had a chance to trade on it.... Bank A decides to lift the offer. Negotiations ensue as to the number of bonds that Bank A will buy / Bank B will sell. The IDB shuttles back and forth between the two parties until everything is agreed. Eventually they agree on a size of 1mm CBs. This means that ...Bank A will pay 101.5 plus the brokerage. In this case the "bro" is an eighth so Bank A pays 101.625 for 1mm XYZ CBs.Bank B will sell at 101.5. Because Bank A lifted Bank B's offer, Bank B does not pay any brokerage.Finally, it's worth pointing out that this statement "it is all about knowing how much a broker payed for its bonds" shows a deep misunderstanding of the CB market. As a buyside trader you will choose to buy CBs from the bank showing the cheapest offer. The bank that shows the cheapest offer will be the bank that already owns the bonds. Therefore I would guess that 9 out of 10 times the CBs you buy will not be sourced through the IDB market but will come out of inventory. An ability to develop and manage inventory is a key competitive advantage in running a CB market making business.Hope this helps

Johnny, can't thank you enough for your explanation and detailed example. I'm a little new to the CB market so I need a lot of education. My curiosity about the interbank bank market from a buyside perspective seems more from high yield convertible trading. Banks are less reluctant to hold axes on these names and source bonds through the "Street". One more last question. When a bank buys a CB on the "Street" (e.g., through an interbroker dealer) how is the delta or equity traded or is it traded at all. As an example, if bank A lifts an offer on a CB with a 50 delta are the stock shares traded through the interbank dealer or does the bank CB trader sell short the shares through its own equity desk? Also, what does "upstairs" mean. Does it refer to selling a CB to another desk at the same bank?Thanks again!! You've been a great help.

"My curiosity about the interbank bank market from a buyside perspective seems more from high yield convertible trading. Banks are less reluctant to hold axes on these names and source bonds through the "Street"."Yes, I agree. Although I would stress that market makers should look for bonds in these places in this order (1) their own inventory, (2) their own prop desk, (3) get the salesmen to call their clients and (4) if all else fails, go to the street. But I agree that (4) is more likely in the case of HY CBs."One more last question."Let's start counting ... "When a bank buys a CB on the "Street" (e.g., through an interbroker dealer) how is the delta or equity traded or is it traded at all."First, let's get the jargon straight. Otherwise you end up sounding as out of touch as your dad discussing the latest music "Yo Daddy-Oh!". CBs can be traded through IDBs in two ways:"Outright" in which only the CB is traded. > The bookie might shout through to the trader "one-and-a-half bid XYZ outright".> Only ten years ago practically all CB trading through IDBs was done on an outright basis. > Everything is as discussed before."On swap" in which the delta hedge is also traded. > The bookie might shout through "2 offered XYZ against 53" meaning that the XYZ CBs are offered at a price of 102 (the bookie assumes you know the right big figure) against a stock price of 53. > Trading on swap now accounts for the majority of CB trading through IDBs.> The delta is usually not disclosed up front. In the event that a trader wants to lift this offer, the IDB then has to shuttle back and forth getting the two sides to agree the size (as before) and also the delta. In the case of HY bonds there can often be substantial disagreements on the delta. It is not uncommon for trades not to get done because of failure to agree on the delta. > The shares are almost always traded through the IDBs directly from one CB trader to another. In the old days some IDBs were not able to clear equity trades in some markets, so special arrangements had to be made. Usually this meant that the IDB would tell each trader who their counterparty was, thus breaking one of the cardinal rules of IDBs which is counterparty anonymity. Those days are now over. > Final point on this: in the options markets traders talk about "crossing delta". No-one ever says this in the CB market. Think of your Daddy-Oh."Also, what does "upstairs" mean. Does it refer to selling a CB to another desk at the same bank?"Aha! I knew there would be more than one question! "Upstairs" is a phrase that comes from the old days of trading on exchange floors, either derivative exchanges or stock exchanges. In the old days there were floor traders (can you imagine, they still have these in some parts of the US! ) and "upstairs" traders. The "upstairs" traders were usually either proprietary traders or longer-term traders, as opposed to the floor traders whose business was all short-term flow trading. Now that open outcry floors are pretty much a thing of the past, nearly all traders are "upstairs" traders in the literal sense. However, the phrase is sometimes used to indicate longer term prop traders, as opposed to short term flow traders. But it's a silly term. People should just say "the prop desk" if they mean the prop desk. Hope this helps. Please let me know your bonus date so that I can come and collect my 10%.

JohnnyYou're a seasoned man of the market!! What would I do without you. I'll be happy to share my yearend bonus with you. Don't expect to much though. I just graduated from undergrad and moved into a convert shop - mostly doing equity research for now and listening on trades. You knew it was coming, but I have one more question which doesn't deal with interbank brokers. When a buyside trader offers bonds to a bank, and the sales person comes back and states "do you need protection." What does providing "protection" mean? Does it mean that you get a last if another shop offers bonds to the sales person at a lower price? Thanks!

It's probably easiest to answer this with an example. You can be the buyside trader wanting to sell 5 million XYZ convertibles and I'll be the market-maker at a bank. A salesman acts as the go-between, but he only relays the conversation between us, without adding anything himself, so I've left him out for the sake of brevity.K: "What's your price in XYZ convertibles?"J: "101 to a half in a million" .... means I would buy up to 1mm at a price of 101 or alternatively I would sell up to 1mm at a price of 101.5K: "And what would you say in 5 million?"J: * correctly suspects a seller* "three-quarters to a half" meaning 100.75 - 101.5 bid - offer.K: "I'm looking to sell 5 million, if I leave you an order at 1 do you think you could get it done?" ... means if K leaves an order with J to sell 5 million at a price of 101 what are the chances of success?J: "Chances are pretty good. I'll protect you at three-quarters in the size if you leave the order with me for an hour."K: "Sounds good. Work it at 1 and protect me at three-quarters in the size. I'll leave it with you for an hour."K wants to sell the bonds at the highest possible price. It looks as though the best way of doing this is to leave an order with J to sell the 5 million bonds at 101. However, this runs the risk that the market might move down before any of the bonds can be sold. This would then leave K in the awkward position of having to sell at some lower price, like 100.5 or maybe worse. J "protects" K at 100.75, meaning that J guarantees a lowest possible selling price of 100.75. If for some reason J cannot get the order done at 101 then K's downside is limited to selling the bonds at 100.75.Hope this helps. I'm looking forward to my cut of the profits ...

Some great answers from Johnny. This is quite an informative thread.Just to confirm ... it is still 1/8 you pay away to a bookie. You don't usually pay anything on the stock side, though you might if it a US stock or ADR.From the market maker's point of view:You will generally know the delta the CB is trading on (market delta) from hearing it a few times when the stock is around that level.. nothing scientific and you can always ask. So if the stock is at EUR34.50 the price will be 100.5 - .75 vs. 34.50. Sometimes though the bookie or client will 'delta chisel' you - that is, claim they wanted to trade on a higher(lower) delta - this will happen if the stock has moved significantly from the level traded (e.g. if the stock goes up, claim they bought bonds/sold stock on a higher delta because it means they can sell more at the higher price.)Also the bookie is likely to be making more of a turn that 1/8th if he can. E.g. tell you the price is 100.75 offered when he knows he can buy them at 100.625. You will probably guess he is doing it, but not care too much since its the bank's money/client's fill and you know the bookie will take you out to a strip club later on.In all, I reckon you loose around 25bps each leg you trade in paying various people. certainly in london I think this market is ripe for some screen based trading instead of this ancient system of IDBs.

Johnny (aka. Trading Guru), you're truly giving me an education. While we are on the topic of trading, I might as well throw some more questions at you. This is best asked through an example:Buyside trader: how are you making YHOO?Marketmaker: 101-101.375 vs 45Buyside trader:I'll hit your bid and sell you 2 million bonds.Marketmaker: Done. Have any more to follow?Buyside trader: I'll sell you 2 mill more at 101.125.Marketmaker: I can't pay that, but I'll try to work it. I'll send a Bloomberg out with a level of 99.875-101.25. Question: Shouldn't the marketmaker just Bloomberg a one-sided offer at 101.375, and if he/she gets lifted come back to me and buy my bonds? Or does the marketmaker always show a two-sided level, and if the marketmaker gets hit again by another customer does the marketmaker have an obligation to give me a last chance to sell the bonds to him at the lower price?Lastly, where can I send your check????

"Question: Shouldn't the marketmaker just Bloomberg a one-sided offer at 101.375, and if he/she gets lifted come back to me and buy my bonds?"Your only concern is whether you get your order filled or not. What the market maker does is the market maker's business. You can voice a preference if you like, but then I guess the market maker could start telling you how to do your job too, right?Let me go on a brief digression about market makers. First, a market maker's world is driven by asymmetric information. Market makers survive and prosper by holding their cards close to their chest. Therefore I would be surprised if any market maker were to tell you what he was going to do in order to fill your order. Market makers just aren't built that way. Second, a key skill of a market maker is to understand how much the price should move by for any given size of trade or order. Third, another key attribute of a market maker is to know who has got the bonds and what they are likely to do with them. One of your key skills as a buy-side trader is to understand the strengths and weaknesses of various market makers. Come the day you have some big size to buy or sell, you're going to need to know who to trust. Don't treat the mms as the enemy. "Or does the marketmaker always show a two-sided level?"Not necessarily. Sometimes a mm working a sell order will just have the sales people show a cheap offer inside the spread to their clients. This is called having an "axe" as in an "axe to grind". Sometimes they will show around a lower two-way price. You have to know the whole picture to answer this."If the marketmaker gets hit again by another customer does the marketmaker have an obligation to give me a last chance to sell the bonds to him at the lower price?"In an over-the-counter market like CBs there are few formal rules, but lots of etiquette. Good etiquette and good business sense would require a market maker to keep in touch with a client for whom he is working an order, including showing a lower bid as you described.You can send my cheque to Bank Nonius, Account Ref: Johnny Asset Management. You choose the amount.

Johnny, thanks for all your advice. For a young person just starting out, you're a blessing. I can't resist asking a seasoned trader more questions. Could you please expand upon how a salesperson/trader makes markets - from a converts perspective if possible. For example, if buyside trader wants to sell bonds in large quantities (e.g., $20mm) how should the bidside trader approach the sales person in order to get the prices. Also, from the sales person/sellside traders' point of view, how do they match buyers with sellers? Lastly, what are some tricks that salespeople do to screw buyside traders. A trader in my firm consistenly tells me not to trust any salesperson. He states that they are all in the business make as much money off of us as possible. How do you keep salespeople in line? Thanks!!!Check is in the mail.