Most Capital Intense Product Areas within S&T?
can anyone shed some light on which products (commodities, rates, equities, credit, fx; and their derivatives) are more capital intense, which ones to a lesser extent and why?
Typically, the riskier the product, the more capital you need to put up on margin to hold a position. So rates- particularly the short-term stuff- and fx are going to be less capital intensive, probably followed by corporate bonds and credit derivatives if you measure exposure based on notional- probably then either commodities or equities.
Long-term, risk is roughly proportional to margin.
Actual securities (physical bonds) are the most capital intensive. The way Basel works is that each product is given a Risk Weighted Asset ratio based on it's current rating and underlying collateral. The ratio (between 0 and 5) the ratio is multiplied by .1 and the MV to get the capital required. I'm not sure why the ratio is multiplied by .1, but it just means that the most capital that is held against an asset is 50% of market value (5 x .1). The capital on a AAA bond might be .2%, while the capital on a BB bond will be 50%. Capital requirements are calculated quarterly or annually (I forget which).
If you google Basel II, I am sure you can find stuff that goes into greater detail
this is a tricky question...I do agree with the poster above who says that the amount of margin you must post is a factor, but high-risk trades arent what i usually think of as capital intensive. As a bond trader, I tend to think of capital intensive trades as trades that use alot of balance sheet and pump up leverage..
for example, lets say there is a dislocation the front end of the cash bond market...ie you think that 6 month bills are cheap to 3 month and 9 month bills for some reason and therefore you want to put on a very tight relative-value trade that captures this dislocation. Because the dislocations are small and because of the low DV01 of a bill you will need to put on billions of notional value to make this trade worth while. To me this is classic "balance sheet trade" where you might get a tap on the shoulder from the risk guy or the head of the desk being like "is it really worth 2bps to hog so much balance sheet?". To me that is a capital intensive trade.
Contrast that with a high-risk, high-margin product that doesnt require parking the actual physical security on the firms balance sheet...like just buying a bunch of oil futures. The futures probably require much more margin then the above RV bill trade, and is in most ways much riskier, but it doesnt require you to either hold or finance large physical positions on your balance sheet. So to me the amount of margin posted is not the best way to judge how much capital is used.
In other markets people may view the term "capital" differently.
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