In preparation of S&T interviews, I've seen many examples of equity trade ideas that are commonly asked in interviews. If I am interested in Fixed Income, is it probable that they could ask for a FI only trade idea?
If so, can you provide an example to illustrate what depth of explanation I need... For instance, for an equity, you could reference current prices and ratios, indicate corporate actions to potentially cause price movement, and/or general macroeconomic shifts.
How would I do this for an FI idea?
Thanks!
They would be looking for something rates related. Talk about where you think the 10yr note is going or if you really want to standout, you can talk about spread trades (curve flattening or curve steepening trades).
If it is something specialized like mortgages or public finance, they will probably ask how to hedge out some of the risks of the security like credit risk or interest rate risk (CDS and treasuries).
Apart from that, they actually ask some equity and FX market related questions because they want to make sure that you watch all the different markets and they know that apart from the 10yr, most candidates watch FX and equity markets much more than the fixed income markets.
Gekko, you are johny on the fucking spot man...mad props
As Gekko said, know what curves have done and have an opinion on what they are going to do, therefore make sure you know of any econ numbers/rates decisions etc coming up. In addition to what Gekko proposed, you can also look at trades between gilt/treasuries curves for example.
Another good resource I used to prep for interviews is the markit site with CDS index prices: http://www.markit.com/markit.jsp?jsppage=indices.jsp
They also have volatility indices which if you can get a good trade idea with credit vol it would impress (altho prepared to get drilled afterwards). Anytime you venture into the complicated, they will try to call you out to make sure you know your stuff.
FI, not much different actually. Well I should say for corporate credits. If they asked you about FI ops what you could retort w/ options for them: corporates, municipals, treasuries, etc. But I would just role with corporates since you could likely roll into easily from equity. Here's some things I would touch on:
Fixed income is different than equity in that you know the end value (YTW), so focus more on the immediate flexibility of the bond than trying to determine value. Although I will say for bonds w/ higher duration, and that require stronger conviction, you could run a DCF to get terminal value of the equity == maturity to date. More equity on the BS means less risk for the bond holder and visa versa. That's another thing to keep in mind, fixed income is higher up on the cap structure, ergo for the more risk averse, so make sure to work that into your pitch.
Yeah, i recommend that most people stay away from advanced topics like credit vol unless they understand it completely, because you will get grilled and if you don't know too much about it you have essentially shot yourself in the head.
i really like that gilt/treasuries trade or your could do a gilt/bund (UK and German Sovereign debt) trade idea. These are all spread ideas, and when you talk about them, you would have to say whether you think the spread will increase or decrease. If the spread increases it means that the UST is gaining value and the gilt is losing value, and vis a versa for the spread tightening. Then you can talk about factors that might make the spread widen (more risk taking in Europe as fears about the debt crisis subside, along with uncertain economic data in the USA)
True, but I think credits could/would be an easier segway from equities questions.
Not necessarily, general equity market/corporate expectations generally fit pretty well with macroeconomic trade ideas. It all depends on whether you're more interested in macro or micro level.
For example, suppose you think corporations will outperform and the economy will recover strongly in the next few years. You could go: Future economic growth --> inflation. Curve is currently pretty flat, perhaps the belly is rich relative the short-end --> Put on 2s10s steepener.
Something like that, where you can tell a story, then show you know how to execute based on your opinions.
On the micro side, a simple trade could be: I think the corporations will face hard times/a particular company or industry will not do well and their borrowing costs will rise. I'd sell/borrow their debt and duration hedge with treasuries, expecting the credit spread to widen.
Whatever trade idea you present, make sure you have (i) target upside, and (ii) your stop loss point (puke point)
^^ Agreed
Re: Revsly - I realize you were just making an example, but I think it illustrates a point.
You mentioned that 2s10s were currently pretty flat and you'd expect them to steepen if the economic recovery accelerated. In actuality, 2s10s are very steep (although not as steep as they've been in this cycle), and are expected to revert to normal levels (flatten) as the economy recovers in 2011 and 2012.
This is a problem I get when I interview people for trading jobs - they know their textbook economic theory (economy grows = curve steepens, vice versa), but they don't know current market conditions, trends, and forecasts. If you are going to talk a trade, know the market.
Suggesting a trade isn't just a test of your ability to grasp cause-and-effect - it's also a gauge of whether or not you actually follow markets and have an inherent interest in them. You can teach anybody to trade, but you can't teach them to love it. If you talk up a trade you don't know, not only do you look incompetent, but you also appear dishonest because you've professed to know something about the market and can't back it up.
This is not to say that your suggested trade can't be simple, even cliche. Just know it inside and out.
That may be possible, but a steepening curve would not be a ridiculous concept. I was mostly just illustrating a logical path, but it could certainly be argued that sure the yield curve is fairly steep, however 2s10s is what, roughly 70 some bps lower than this spring? I think it could certainly be a valid trade if you expect economic recovery (or at least inflation), yet believe the Fed will have to keep rates low in the near term to combat unemployment and encourage lending. I'm not saying I'd do this, I was mostly making an example, however I'd find this to be an acceptable answer, particularly because no one knows that the right answer is.
For me, I much rather have people be able to analytically break down a trade. That said, I'd certainly want them to know what's going on, so I see your point.
In more general terms, make sure you think about a scenario analysis and look at all the potential risks that you might face, and then look at if you can hedge out some of these risks without limiting your upside. Think about your plan b,c,d etc, in essence not doing a sales pitch but trade idea.
Wow, thanks, these are all great ideas. With spreads trading in general, can you recommend a website that could give some more basic information on this? I'm an engineer and do not have many courses that go this into this far of depth financially.
Yeah it's called the Barclays Agg and it's expensive. I wouldn't try to talk on points you're not super familiar with.
You can wikipedia it (or investipedia).
You understand how FI securities have a yield so say the UST is yielding 350 basis points (3.5%, but you will use basis points when you start your career so get used to it). and a corporate security is yielding 750 basis points. The spread between those two securities is 400 basis points. The Treasury is worth more than the corporate bond (simple yield price relationship). If you think that the spread will tighten (decrease), you will buy the corp bond and sell the UST (usually the 10yr) It means that you think UST yields will increase more than Corp bond yields, corp bond yields will decrease more than UST decrease, or UST increases and Corp bond yields decrease.
Since you want to capture just the spread you need to make the trade delta neutral (duration neutral) by hedging out the interest rate risk. Duration is a bond's price sensitivity to changes in the yield curve. Lets say UST has a duration of 8.4 and Corp had duration of 4.2. That means that for every .01 change in yields the price changes for the bonds are 8.4 basis points and 4.2 basis points. Since you are long the corp and short the UST you are essentially short 8.4 UST duration and long 4.2 corp bond duration. To make the trade delta neutral you will go long $X corp bond and short .5X UST.
Make sure you know everything about duration when you go into an interview..not knowing about duration is almost an auto-ding for most interviewers.
The above principal of hedging out the interst rate risk using treasuries and making the trades delta neutral to capture just the spread is what banks do on a daily basis.
Now there are lots of other risks such as credit risk or vol risk, but those are more advanced and probably would not be covered in an interview with someone who is not a finance major. Just know that CDS is for credit risk and if they ask about some other risk, say use some sort of derivative instrument.
I am a buyside trader and 70% of what I trade is G10 interest rates.
Be careful in pitching a rates idea unless you have real understanding of how rate markets work. Nobody expects an undergrad to have a full understanding of trading the yield curve but basic questions that you should know if you are pitching a curve trade are "what is the carry and roll on that position?"..."what is your view on the Fed and how will that effect your trade?".....You should really understand the relationship between the forward curve and the spot curve and how that effects your decision-making process. I am not going to give you the answers but if you dont understand that stuff then you are better off saying nothing. To be fair I knew none of this stuff when I was right out of college, but if you are interviewing for a high-level job right away (i started as a back-office trade entry clerk) and you are trying to differentiate yourself by displaying knowledge of fixed income then you should know this stuff.
My perspective is that of someone pretty senior though...as sad as it is, many sell-side people will not question you as hard as I would because their knowledge is spotty and they will be afraid of looking like idiots. If a 22 year old came into where i work with a curve trade i would probably crush him just out of spite, but most of the sell-side guys you will be interviewing with will probably be much easier.
Since when did delta = duration, Gekko?
There were some things he said that didn't quite make sense--not necessarily in any terrible/dumbass way, just a few words/phrases used unusually that threw me off, which is why I was asking.
Re: Bondarb
Good call on the need to know carry & roll. A good way to avoid being pressed on this would be to suggest trading spreads via futures (ZT, ZF, ZN, ZB, UB).....would offer better liquidity as well.
The duration of a bond isn't constant, it is also a function of yield (rates), and changes at every point on the price-yield graph, so I don't think you can simply take long $X corp short 0.5X UST position just once and think you are perfectly hedged, because those durations move as yield/rates move. (one has to dynamically hedge??)
Also, if you want to capture the spread between UST and Corp, and if you hold both positions to maturity and get back par value, you will realize the spread without hedging right? why would this position need to be hedged assuming it is held to maturity? Am i missing something here?
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