Key Fixed Income Terminology

Picking up right where I left off.

Even according to my own notes, this section just kinda… starts. Like this:

Heh — I was about to wave the starting flag and the first “miscellaneous term” just walked in: LIBOR.

Anyway. LIBOR is the benchmark for floating rates, and the headline example is that it’s the standard floating rate in the swap market.

But hey — did you know?

In Korea too,

KORIBOR is the encouraged risk-free rate for the domestic private sector. Historically the CD rate was the go-to in practice, but CDs have been disappearing, so apparently they cooked this thing up.

Wait, then does the US use Britain’s LIBOR??????

Yep — USD-denominated LIBOR is the benchmark.

This kind of useless trivia just sort of… piles up on you when you work in the industry. T_T T_T T_T

Sorry for spouting random stuff. T_T T_T T_T lol lol lol lol

OK let’s keep moving!!! heh heh heh

So look, this whole section is “a few miscellaneous term summaries…” — it’s not one logically connected concept building on another, it’s keyword study for the exam. Just buckle up.

So, suddenly…

Bond issuance methods.

Broadly split into 2 buckets: public offering / private placement.

But for exam purposes the one we care about is public offering, right.

The text is too tiny… let me just retype it.

The book introduces 2 flavors of public offering:

1. Underwritten offering (full underwriting method). Say you’re trying to issue 300 billion won. You need to ask the market what rate it should clear at — that’s done by the IB (lead manager) and it’s called demand forecasting (Book Building). Then the IB acts like a wholesaler: they take the whole inventory and absorb the volume themselves.

   (Catch: if some institution participated in the demand forecast and quoted 5%, and you actually issue at 5% — they have to come in. If they don’t, they get penalized — blacklist, the whole thing.)

   • I’m a bit removed from bond issuance in practice, so I don’t know the inside baseball super well, but stock issuance works similarly..
   • One thing to watch out for though: going in more than other asset managers is riskier than going in less. Because getting wrecked alone is a way bigger risk than getting wrecked with everyone… heh

2. Best Efforts Offering. A method where the IB goes “we’ll do our best to absorb the volume.”

That’s the corporate bond story. For government bonds, they go through an Auction, which not just anyone can crash — only primary dealers (financial institutions) can participate. Then those entities trade them on a secondary basis to everyone else.

Shelf Registration (일괄신고제): the kind of thing you have to memorize for the exam…..;;

OK so — say you’re going to issue 300 billion won total. But you’re not gonna dump it all in one shot!!! You wanna issue in pieces over time.

In that case, you file the registration paperwork for the full 300 billion upfront, all at once, and then issue bonds in tranches whenever you need to. That’s the system.

(The name supposedly comes from the image of all the registration documents being placed up on a shelf, ready to grab.)

On/Off-The-Run Issue

Say there’s a government bond issued last year with a 3-year maturity (so its remaining maturity right now is 2 years).

And there’s another government bond just now issued with a 2-year maturity.

At this exact moment, those two bonds are identical — everything should be the same.

But the freshly-issued one has way more trading volume. Its price is also a touch higher.

That fresh one is the On-the-run Issue.

(Off-the-run Issue: seasoned issue ☜ usually barely trades at all)

The on-the-run issue has a price every single day, so —

in particular, the on-the-run issue from the Treasury is used as the BM!!!!!

I’m underlining because this matters!!!!

When the word “benchmark????” comes up, unless someone specifically tells you otherwise, just think: it’s a government bond, and the most recently issued one is the benchmark~~~~ heh

Serial Bond (연속상환채): Issuing bonds with staggered maturities at regular intervals. From the issuer’s side, this has the same effect as paying off the debt in installments.

Medium Term Note (MTN):

The name sounds like it has something to do with maturity. It does not. Zero. None.

You file a shelf registration all at once, and what you issue piece-by-piece whenever needed — that’s an MTN.

(Most MTNs are apparently CPs.)

CP (commercial paper):

CP is issued with a maturity of 270 days (9 months) or less, and it’s issued on credit alone — no collateral.

It can be rolled over at maturity. (Pay off the existing one in full, then issue again.)

Reasons rollover might not work (rollover risk):

1. The company is wobbling.
2. The market itself tightens up. (Flight-to-quality, that whole thing….)

Structured Financial Instruments (구조화된 금융상품)

When people hear “structured bonds,” they usually picture stuff like ABS or CDO — but that part shows up at the very end of Fixed Income Level 1, you know????????

(Genuinely super fun, by the way~~~~~~~)

We’ll get to it at the end. Since this section is “a few miscellaneous term summaries,” we’re not gonna go deep into other types of structured products here. It’s more of a quick tour???? — peek at a couple, move on.

For the exam, what you need is basically: when you see a “blah blah~~~~” description, can you name which structured instrument it’s describing? So I think organizing them by characteristic is the move.

1. Yield Enhanced Instrument:

Structured to chase higher returns by taking on extra risk…

Headline example:

CLN (Credit Linked Note): = Long Straight Bond & Short CDS (credit default swap)

Aside)

Hold on…. What even is a CDS!?!?!?!??

Banks are usually the main players doing CDS deals, so let’s say Bank.

1. A Bank buys some Bond. They pay money along the black line, and in return they receive a Promised Cash Flow along the red line.

   This cash flow has two flavors of risk baked in:

   • The risk that the risk-free rate (which moves all bonds) changes.
   • The credit risk specific to that bond’s issuer (Samsung issued it / GD park issued it — those are very different things).

2. So this Bank goes to another Dealer (typically another bank) and says:

   “Hey. I’ll pay you a Premium, faithfully. But if a Credit Event happens on that bond, you eat the loss.”

   In other words — it’s literally an insurance contract. That’s why we call it a premium (insurance premium).

This whole structure is a CDS.

Inside the structure, the bond is the insured asset (or reference obligation). In this trade, the Bank is the CDS buyer (Long CDS) / the Dealer is the CDS seller (Short CDS).

CDS gets covered properly at Level 2. As of writing this post, I’ve finished all the Fixed Income Level 2 lectures, so haaa………. CDS………. my mouth is itching to talk about it lol lol lol lol lol lol lol lol lol lol lol

I’ll bite my tongue and move on.

Anyway!!!!

Moving on from Yield Enhanced Instrument!!!

(Just to be clear: it’s NOT that Yield Enhanced Instrument = CLN. CLN is one example under that umbrella. Don’t get the two confused!)

2. Capital Protected Instrument

Example given: ELB (Equity Linked Bond).

You raise 1000 in cash. You buy a bond such that even after n years, your principal is recoverable.

(Hot take — calling the amount you’d earn at the risk-free rate something other than “principal”… isn’t that kinda mocking the investor?!?!?!?!?)

So there’s a bit of money left over after the bond. With that leftover money, you go Long Call on something. Structure:

• Stock rips → jackpot~~~ huge gain.
• Stock doesn’t rip → no big deal, you still get your principal back~~~

(That’s not bad? Maybe I should buy a lottery ticket every week with my leftover cash lol lol lol)

(But honestly, wouldn’t Long Put be better than Long Call? lol lol lol In finance the truth is: things rise slowly and fall fast, and nobody knows when a stock is gonna out of nowhere, literally Unexpectedly take a correction lol lol lol)

Leverage and inverse 2x weren’t only a stock-market thing lol lol lol

They exist in bonds toooooooooo lol lol lol lol lol lol

Of course, they weren’t created with the spirit of “LET’S GOOOO!!! DOUBLE IT!!! TEN-BAGGER!!!!!!!!!!!!!!”

The actual upside of having a 2x or 3x is: when I want to hedge, I can grab as much exposure as I need with less capital. The menu of choices widens. That’s the legit reason these things exist.

But also, let’s be honest — they also made these products because they knew there’d be demand from the “LET’S GOOOO!!!!” crowd…… heh

5. Repo (Repurchase Agreement) — this guy called repo,

it’s basically a pawnshop.

You hand over a $100 item as collateral and go:

“Just lend me $95. Later when I bring back $100, give me my item back too!”

(And as a backup — if I can’t repay, don’t give it back; sell it on the market and recover your $100 that way.)

That’s the trade structure.

OK, now there are some terms in repo-land we need to know.

You handed over the $100 item and pulled in $95. Lending out money with a little cut shaved off the top like this — that cut is called the hair-cut (= repo margin).

In this example the haircut was 5%.

If the collateral is more volatile (price swings around), the hair-cut gets bigger. If the repo period is longer, the haircut also gets bigger.

So they lend money like this, and in the typical repo market the collateral is government bonds.

(When the monetary policy committee announces a rate move bang!, employees on a certain floor of the Bank of Korea go bababababababababak and start firing off repo trades — I heard this from a professor who came from the BOK lol)

But in reality…… they don’t actually physically hand the item over to borrow the money. There’s a form of the trade where the vibe is: “Bro, why on earth would we bother with actual delivery on the collateral…. Instead, I’ll just sign a contract saying I won’t dispose of this thing anywhere!” (Of course in those cases you pay a tiny bit more interest than when there’s actual delivery.)

Oh, and: giving the item = Repo / taking the item = Reverse Repo.

For exam purposes you also need to know which one it’s called depending on which side of the trade you’re on!

Phew……….

The miscellaneous-term tour is done….

From the next part on, Fixed Income actually begins.

That’s when Valuation kicks in…..

And it’s the kind of section where understanding it thoroughly thoroughly thoroughly will keep paying you back over and over and over — so I’m carrying it into the next post!!!!!!!!!!!

Originally written in Korean on my Naver blog (2021-12). Translated to English for gdpark.blog.