Principles of Quantitative Development

2.3 MIDDLE OFFICE

The middle office typically handles the inception control checks as well as the daily processing, reporting and monitoring of the trades. They also manage the risk aspects of the trading activities at a portfolio or bank book level.

Looking again from the narrow perspective relevant to us, the MO consists of product control, trade control (also known as business or treasury control), risk management (market, credit and operational risks), limits monitoring, rates management, compliance and reporting, analytics, asset and liability management, etc. Figure 2.3 depicts the structure of a typical middle office and the process and information flows in and out of it.

2.3.1 Product control

Product control deals with daily profit and loss (P/L) computations and explanation. Product control houses the middle-office product experts with a thorough understanding of financial accounting. They filter the trading positions and P/L before the numbers reach the finance department in the back office and get reported and disseminated for public consumption.

They also endeavour to understand and explain the P/L. Profit and loss explanation is the process by which product control verifies that the P/L movement is consistent with the market parameter sensitivities of the underlying trades. In other words, they use the Taylor series expansion for the P/L (often implemented by quantitative developers) similar to the following:

Figure 2.3 The structure and process flows in the middle ...