>> [CROSSTALK] >> Here's the trainer model. Okay, on the horizontal, instead of price risk that comes from inventories, okay, from your positions, we're going to have liquidity risk. The scale of liquidity risk that your taking. [NOISE] As a dealer. Again I'm not writing everything on here, but you understand this is the maximum position and we leave in the background for a moment what might be determining that, you know this is the maximum short, you know, this is, this is, so we have all of those. What's the price? The price that's, that's relevant here. Okay. The overnight rate, there are two prices. There's one is the overnight rate, and there's one that's the term rate. Okay. Let's, what, what really is important here, is the spread between these. You know, because that's the profit. Right. It's the spread between the overnight and the term rate. The difference between them. Just to make things simple for exposition, at the moment, let's think of this, the, of the overnight rate as basically being fixed by the Fed. The Fed fixes the Fed Funds rate, the Fed Funds rate through arbitrage is the same as the repo rate, and we'll come back to that. So, this isn't a distraction. Okay? And we're going to come back to that today. We're going to do, we're going to do that today. Okay? But, for now. Let's just focus on the term rate here. So this is a term interest rate, is the price that dealers care about here. Term interest rate here. Right? Now this is an interest rate. The trainer model was about prices. Asset prices. So it's the inverse. Right, it's the inverse. And so our bid ask spreads are going to be upwards slopping, okay. And there going to be flipped, okay, as, as well. So, we're, the model, is like that, model's going to be like that. Where we think of the dealer as quoting prices, well, quoting, quoting yields. Okay. Not, not prices in the money market, depending on their on their current exposure. So this is the bid curve And this is the offer curve. Okay. They're, they're flipped because we're talking about, about yields instead of prices. But conceptually, it's the same. Right? We understand that for every yield there's a price, for every price there's a yield. We haven't introduced anything else there. We're just using the conventions of money markets that all prices are quoted in yields instead of, instead of in, in price terms. Okay what this graph, what this dealer model applied to money market is telling you is that in order to, if dealers are going to be willing to take on an additional liquidity risk, they have to be paid. And, and what they're paid is this spread between the term interest rate and the overnight rate, okay. That's their profit okay. Now they could still you know, there could be a run on the bank or whatever, but if you give em a big enough spread, they'll say, alright, give it a whirl, life is short, okay. And they'll, they'll expand their, they'll expand their balance sheet and they'll take more, on more liquidity risk. Okay that's what this model is sort of telling you, here. Alright. The Traynor model of bond prices, okay, says the price of bonds is going to be moving around because of the net position of the dealer. The net position of the dealer in, according to these numbers, is 515. Right. That's the number that we worry, that we're concerned about. We were thinking about the security dealers at security dealers. The number we're concerned about when we're thinking about them as liquidity dealers is that number, 942. There's no reason for these numbers to be the same, right. That's the point, that's the point. That the dealer Is making money on both sides. And it's, and it's, and it's adjusting the margin on both sides. It can change it's bond position, okay. Without changing it's liquidity risk position, right. Because it can, it could expand both sides, here, and here. Without changing it's liquidity risk. It could change it's liquidity risk position, without changing it's bond exposure, okay. So you can, you can adjust both margins, okay. And a profit making, profit seeking dealer will adjust both margins naturally. So even though I say it's a Gestalt switch, you know, that one side from one point of view, the security dealer is dealing in bonds and in the other they're dealing in money, actually they're dealing in both. Okay, and they're dealing sort of separately in both, separately. They don't, what they do on one side doesn't imply that they have to do something on the other side. It implies that they have a bond position they have to finance it but how do they finance it? They could finance it over night, they could finance it at term, you know, there's a lot of things they could do. I'm showing here a story about dealers, who we understand. But this is the same story that you would tell about banks, that we don't understand yet. If we think about this as a deposit account and this as a term loan to a company or something Okay, this same diagram, this same way of thinking, can apply, okay. Banks however, that's, that's thinking of a bank, as a kind of security dealer, except the securities they're dealing in is money, okay. The other side of a bank, is the payment system. Which is what puzzled us here. Banks are both involved in the payment system and in the money market. We couldn't figure out the payment system thing. Okay. When we started. It was too much of a jump. But we now, at least, are able to understand, we have a model of the banks involved in the money market. Okay so let's hold onto that we're making progress. We're moving toward understanding how banks can be thought of as a kind of dealer.
