Dick Sweeney

SEBank (B). Page 2, of 2.

Dick SweeneyDecember 14, 2006SEBank (B)Covered Interest ArbitrageMimi Juselius was near the end of her six weeks training course as a foreign-exchange trader at Scandinaviska Enskilda Banken (SEBank) in Stockholm, Sweden. She had graduated in June, 2000, from Gothenburg University with a major in financial economics, completing a D level thesis, with honors, to earn the equivalent of a masters degree. When she joined SEBank, she was confident of her knowledge of foreign-exchange market institutions, the mathematics of finance especially as applied to international finance, and models of exchange-rate determination. Despite what she had heard from her professors and the bank recruiters, she had still been amazed at how fast things moved in the foreign-exchange market, and how fast she would have to make decisions. For the past two weeks, however, she had been trading on her ownbut under close supervision!and she now felt confident in her abilities to analyze and seize market opportunities, no matter how fleeting they were and no matter how fast she had to think and act. It was August 1, 2000, and she had come a long way.

SEBank was one of a handful of large Swedish commercial banks. Traditionally there had been six big Swedish commercial banks, but the industry was shaking out. Some made acquisitions, both Swedish and foreign, including Swedish savings banks; some were acquired by other Swedish banks, some by foreign banks. The Swedish banking industry was becoming even more international, both in ownership and in outlook.

Swedish firms had long been deeply involved with foreign trade and thus international financial markets, for example, large firms like Volvo, Electrolux and SKF (ball bearings) that sold world-wide and produced not only in Sweden but in many locations around the world. Naturally such firms had large demands for banks international financial services, including foreign-exchange transactions in a whole range of currencies as well as borrowing and lending short-term in all the leading currencies.

SEBank had long been Volvos lead bank for international financial services. The relationship was not much built on sentiment, however. Volvo used other banks, too. Volvo also ran its own trading room, in large part to evaluate the performance banks gave it in filling its orders both for the foreign-exchange and money markets. And Volvo had its own finance company that served as a benchmark and possible competitor.

SEBanks foreign-exchange and money-market dealers sat in the same large airy room, with big windows and a good deal of Scandinavian wood. SEBanks philosophy was to offer excellent integrated foreign-exchange and money-market services. Often a customer wanted to use both togetherfor example, borrow three-months money in one currency, convert the funds to another currency and transfer the funds to its account in a third country. SEBanks foreign-exchange and money-market dealers talked frequently and had good working relationships. The foreign-exchange dealers quotes and transactions showed up on the money-market dealers screens, and vice versa. Ms. Juselius saw what SEBank's other FX traders were doing as well as each of its money-market traders. Often enough, foreign-exchange dealers needed to borrow or lend currency, and had the opportunity of using a money-market dealer a few desks down. On the one hand, the FX dealers could sometimes get a bargain rate by say borrowing from an SEBank money-market dealer who strongly wanted to balance an exposed positionboth got what they wanted. On the other hand, the foreign-exchange dealers were not in business to do their money-market colleagues any favors. To protect their profits and look good at bonus time, the FX dealers had to get the best money rates they could. And they knew that important, sophisticated customers like Volvo wanted the best execution possible.

By the middle of the afternoon, Ms. Juselius had a hunch that she might be able to make trading profits in buying and selling USD against SEK. She glanced at her screen and saw that the last spot quote was 9.1170 bid. She called a Danish bank and, asking for quotes for SEK 1m, received SEK-USD quotes for spot, one-month, three-months and six-months foreign exchange: 80 to 41, 170 to 190, 400 to 450, 600 to 700. While listening to the quotes, she looked at her colleagues current money-market quotes: for customers, three-month USD could be borrowed from SEBank at 6 11/16 and deposited at (or lent to) SEBank at 6 5/8, and SEK could be borrowed at 7 1/4 and deposited at 7 1/8. Bingo! Arbitrage! She caught the eye of the money-market trader nearest her and quickly glanced at her screen while raising her eyebrows; her colleague instantly gave a firm nod yes.

Note: The spot quote of 80 to 41 is to read as 80 to 241, or 180 to 241. Thus, starting with the 9.1170 quote she had seen on the screen, the spot quote is 9.1180 / 9.1241. Why do they do this? Who knows.