Look at real dealers. They have a more sophisticated trading strategy than this okay. Instead of being exposed to the movement of the price and securities, they are more hedged than that. They will have long positions in some securities and short positions in other securities. That move, that are correlated, or move, or move in the same direction. What a real dealer looks like as we know, if you remember back when we were looking at the repo market, a real dealer looks like this. There are securities out here in the world, holders of securities Okay. Which the dealer is, is acquiring with a reverse repo. Meaning, they are lending money to the owners of securities, and taking in the securities as collateral. Okay. They may then sell those securities in order to establish a short position in those securities. On the other side, repo, there's securities out, and cash it, okay? So the dealer is borrowing cash and providing securities as collateral for that borrowing. Okay, so these securities are coming in on the reverse side, they're going out on the, on, on, on the repo side. There's inventories of cash on this side, there's inventories of securities on this side. And the dealer is on both sides of that market. So they're, they don't necessarily have match book. You know, they, they may, they, they're going to have some net exposure, but they have a lot of gross exposure. A lot bigger gross exposure than their net exposure. Not let me, let me just, how can I explain that. So there's gross exposure. By that, I mean just the size of the balance sheet. Okay. And net exposure refers to the net of longs minus shorts. Long positions minus shorts. Okay? And it's possible that you could have a very large balance sheet. But if you're an, have a matched book, you have no net exposure. Net exposure might be zero, okay?. or you could have a very small balance sheet and the, net exposure could be very large because it's all, it's all on one side. And you have no, you have you no hedging on the other, on the other side. So, these two things don't necessarily go together. What we have seen in the dealers, when I, the dealers right now, their balance sheets are very strange. Because they're being pushed around by the Fed, doing its quantitative [UNKNOWN] three, and all that sort of thing. But typically, the dealers have a net exposure that is an exposure to the term spread, if you remember. Meaning, they're long, long term bonds and short, short term bonds. Okay, so they're picking up the, the failure of expectations hypothesis of the term structure as a source of profit for them. They are, they're borrowing short and lending long, just like a bank. Borrowing short and lending long. And they're picking up, so they're exposing themselves to price risk because they have net exposure. But they know that in general exposure to that price risk is a profitable thing to do. Because of the failure of the expectations hypothesis of the term structure. So that's a business to expose yourself to the term spread. And you could expose yourself to other spreads too. That's the dealer business, is building up your gross exposure. Okay, and then controlling your net exposure so that you, you, you have strong, you have strong controls. The trainer model is all about net exposure here. Gross exposure is liquidity risk though, though because your, you have to fund these positions. And if they, they if the person who's on your counter party risk. If they don't pay you, then you can't pay the people you promised to pay and so they're, well get to that later on when we get to banking. Right now in the trainer model, I just want to say it's all about price risk. It's all about price risk and that the that the dealer, the dealer's willingness to make markets. To provide market liquidity has to do with, with their exposure to price risk and their ability to manage price risk. If they can manage price risk very well. They're trying to manage it very well, because that lets them make tighter spreads, and that makes them beat out the other dealers. So, that's the competition. The competition is to, to be good at this business so that you don't have to use a lot of capital and you can, you can leverage up And, and make these are tiny little spreads. They're tiny little spreads but you can make money in this, in this dealer, in this dealer business. So how do you make money as a dealer? You make money as a dealer by having very good access to inventories of securities. And very good access to inventories of cash. You know where the securities are. You know, you know where what, what long only pension funds are holding various securities. So that if you need to acquire them, you can find them. You're not holding the inventories, gross inventories on your own balance sheet. Because then you'd have to finance them and you don't want to do that. Okay, you're letting them hold them on their own balance and when you need them. So when a client comes and they and they want that security you know where to go and get it so you can get it and sell it to them. okay? There's inventories of the securities out in the world. And there's inventories of cash out in the world. So you have a good relationship with your banker. Maybe you're in fact a subsidiary of a banker so you have a particularly good relationship with the banker because they're you. and it's a different part of the balance sheet of the bank and you're just moving that cash back and forth. And that's where the inventories of cash are. The inventories are not on your balance sheet, for the most part, they're out in the world. Just like West Side Market Right? The mangoes are not, you know, they're, they're out in front, but the actual inventories of mangoes are in Jersey somewhere. You know, the, the large ones, if you had to absorb a large order. Okay? They know where they could get some mangoes. and so it's the, it's the same with, with security dealers. So dealers make money, first of all, by having knowledge about this, they make money also by paying attention to their net position. Okay, and moving prices when, so that they don't get bagged by people who know more than them. And they change that bit as spread if the volatility increases, they, they move that around. So. They, they pay close attention to that, and and change it minute by minute if need be, in order to in order to make money. and by offsetting their long long risk exposures with short risk exposures so that they're net flat or near or nearly flat. because every time you're buying right, every time you're buying, you're buying here. Every time you're selling, you're selling here. So, if you're bulk buying and selling you're making this spread. And so the more you can do that okay, the more money you make. That's the idea.
