Rates Trading 101: Interview Questions, Desk Structure, and Exit Opportunities

One of the largest trading desks within any bank's sales and trading division will be the rates desk.

How exactly the rates desk is structured will vary slightly depending on what bank you are looking at. 

However, what you will generally find are silos of traders who focus on distinct areas of the rates universe. Then you will have sales people who are generally a bit less siloed than the traders (meaning they will interact with various trading silos, for instance dealing with clients transacting in numerous kinds of rates products like treasuries and swaps).

Every rates desk will be largely broken down into the following manner:

  • Front-end traders (covering the front-end of the yield curve, meaning the two to five year treasuries)
  • Belly traders (covering the belly of the yield curve, meaning the 5 to 10 year)
  • Long-end traders (covering the long-end of the yield curve)
  • Swap traders (those trading vanilla or exotic interest rate swaps of any duration)
  • TIPS traders (those trading inflation-protected securities)

Occasionally you will see money markets and mortgage-backed securities trading be put under the "rates trading" umbrella. Normally, however, these areas are considered to be distinct desks on their own and we will cover each of these areas in future posts (since they have substantially different dynamics than rates).

The Distinct Nature of Rates Trading

One thing to keep in mind about rates trading - if you are planning to rotate there or join full-time - is that it is quite a distinct environment relative to the rest of the floor. 

Rates are a very liquid, flow-oriented space and it is still quite dominated by humans (as opposed to algorithms executing client trades). What this means practically speaking is that the rates desk is always a bit chaotic; lots of talking, shouting, constant repositioning of books via future contracts, etc.

If you are interested in feeling truly "in the markets" then rates are a great place to be. It's an area unlikely to be further touched by automation and with lots of client flow regardless of what bank you are at. 

Another benefit of rates, as we talked about when discussing regulation in sales and trading, is that rates products obviously revolve around government bonds and thus have a very low risk-weighted asset (RWA) makeup.

What this means practically is that a trader can hold lots of treasuries, futures, TIPS, or swaps on their book without having to have the firm hold back lots of capital against these. Therefore, one can make an argument that on a risk-adjusted basis being on the rates desk is one of the best places to be on the trading floor as you can still get substantial PnL as a trader.

Further, for a sales person, you are very actively dealing with clients in very large transaction sizes. Given that a sales person in sales and trading will get a cut of the flow they bring to the desk, this is a very solid seat on the floor to have.

Of course, one of the reason why banks and regulators alike feel comfortable allowing traders to have large books is because you don't have much volatility in the core rates products.

The reality is also that regulators understand how important it is for large sell-side banks to have big rates books, because they are the predominate provider of liquidity. At year-end and quarter-end in recent years we've seen rates markets dry up quite a bit as rotations occur, which has reinforced how important it is to have deep, liquid, actively-traded markets in treasuries, TIPS, and swaps. 

This is all a bit of a convoluted way of saying: if you enjoy the attributes of rates-products, it is a great seat to have on the floor at nearly any large investment bank.

Rates Trading Interview Questions

Below are some rates-specific interview questions. These are the kinds of questions you may get if you're entering into a fixed-placement over the summer at a bank like J.P. Morgan (see J.P. Morgan S&T interview questions here) or are applying as a full-time analyst.

Don't worry about getting any questions that are too complex. No one expects you to be an absolute expert on everything prior to beginning.

Your first few years on the job as a trader will largely be for learning, helping, and then slowing initiating yourself into one of the silos listed above. Your first few years on the sales side of the desk will largely be learning, helping, and slowly taking over some responsibility for managing clients (and talking more directly with the traders). 

What is the auction process for treasuries?

Treasuries are auctioned via a Dutch auction process. At a specific time, all primary dealers – which includes all the major U.S. domestic banks - must submit bids to the Treasury. Once the auction closes the bids are analyzed and the issue is auctioned at the lowest yield that fills the total auction amount (all those who bid lower, in terms of yield, are filled at this level too).

Importantly, those who bid at a yield too high will not get any fill and those who bid lowest will be filled first at the amount they requested.

Further reading: https://gilmartinir.com/introduction-to-dutch-auctions/ 

How many different issues of treasury notes and bonds are in circulation at any given time?

By definition, 24 2-year treasuries, 36 3-year treasuries, 60 5-year treasuries, 84 7-year treasuries, 40 10-year treasuries, and 120 30-year treasuries. This is part of the issue with any level of automation within rates trading; there are 364 different securities, of varying amounts of time until maturity, that will likely be issued with different coupons, and that will have different yields and prices.

Many people naively think of rates like equities; every 2yr note is the same just like every common share of Apple is the same. This is simply not the case; bonds quickly get quirky!

What are treasury futures in layman terms?

Futures allow market participants to take views on future rate movements in an off-balance sheet capacity. There are six futures:

  • TU (two-year)
  • FV (five-year)
  • TY (ten-year)
  • TN (ten-year, ultra-long)
  • US (30-year)
  • AUL (30-year, ultra-long)

Treasury futures are used routinely in hedging and are incredibly liquid just like the benchmark treasuries are. 

Ultimately, a future obliges the seller to deliver an underlying security (not a future) sometime in the future (so a 10yr future would require a delivery of a 10yr Note).

When do futures expire? Are the maturities commoditized or organized at all?

Absolutely. For futures, a letter will denote what month the future matures in.

  • H (March)
  • M (June)
  • U (September)
  • Z (December)

Putting this all together, if I told you FVZ20 what does that mean?

FV, as noted above, corresponds to the five-year treasury future. Z, as noted above as well, corresponds to December. The 20 simply means the last two digits of the year in which the future matures (so it would correspond to 2020).

Therefore, FVZ20 means the five-year futures contract expiring in December 2020.

Rates Exit Opportunities

Of course, no matter what area of the sell-side you enter into you want to be cognizant of what exist opportunities are possible.

While in M&A, there is a well-established pathway of doing your two-year analyst stint and then leaving, in sales and trading it is much more variable.

Some desks provide a very narrow set of exit opportunities - such as some cross-asset desks - while others provide a broader diversity of exits and more defined recruiting timeline.

Rates trading is one of these desks where you will have opportunities within three to five years to make your way over to the buy-side. I did a rotation in rates trading four years ago and now most of the desk has moved over to the buy-side.

The most frequent place to end up is in some large global macro hedge fund as either an analyst - if you have between three and seven years of experience - or a a portfolio manager if you have more.

Another common exit from rates is simply to move to a different bank, but with a higher title and higher-level of compensation.

For those looking to stay in finance, but looking for a somewhat more relaxed lifestyle, investor relation roles or fin tech startup roles are also very common.

While I would certainly advice some people to stay away from certain desks if they ever plan on leaving the sell-side, I would most certainly not ever recommend someone not pursue rates trading or rates sales because of a concern about exit opportunities. If you want to leave, you will be able to find an interesting role that suits what you're looking for. 

Conclusion

Rates trading is one of my personal favorite areas of the trading floor. While I ultimately decided to go to a different area of sales and trading, I still am very bullish on the present and future of rates.

A word to the wise: rates is flow-oriented even if you are in a silo like swaps. You will be always on your toes and not have much time to think. Trades happen fast as clients demand short-execution times. 

If you are looking for a desk that has a slower-pace, where you have space to think or lulls in the day, then rates trading is not for you.

But if you enjoy flow, enjoy constantly interacting with folks, and are interested in monetary policy then rates is a phenomenal place to be.

As always, feel free to leave a comment if you have any questions!

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