DEFINITION OF ‘TRADING BOOK’
The portfolio of financial instruments held by a brokerage or bank. Financial instruments in a trading book are purchased or sold to facilitate trading for the institution’s customers, to profit from trading spreads between the bid and ask prices, or to hedge against various types of risk. Trading books can range in size from hundreds of thousands of dollars at the smallest institutions to tens of billions at the largest financial institutions. Most institutions employ sophisticated risk metrics to manage and mitigate risk in their trading books.
The trading book has been the source of massive losses for a number of financial institutions in recent years. Such losses often arise because of extremely high degrees of leverage employed by an institution to build the trading book. Another source of trading book losses is disproportionate, highly concentrated wagers on specific securities or market sectors by errant or rogue traders.
Trading book losses can have a cascading, global effect when they hit numerous financial institutions at the same time, such as during the LTCM/Russian debt crisis of 1998, and the Lehman Brothers bankruptcy in 2008. In fact, the global credit crunch and financial crisis of 2008 was significantly attributable to the hundreds of billions of losses sustained by global investment banks in the mortgage-backed securities portfolios held within their trading books.
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