I heard that most bank do back-to-back trade to hedge their exposure. The question is how do bank make money if they already hedge out the exposure?
Their profit is in the bid-ask spread and fees.
Thanks for the reply. Don’t they have to pay fee to enter hedge deal? Are you saying fee received from client deal is greater than fee pay for hedge deal ?
Depends on the hedge used. Like if they do an interest rate swap where the client pays fixed rate and receives LIBOR (3mths), then the bank can use interest rate futures to hedge the Interest rate risk (by putting a small initial margin).