Interest Rates and Bonds (1)
It was January 1994. Finals were all done, and with winter break just around the corner, the kids were buzzing with excitement.
"Alright, let's start class."
Tap tap. I rapped the whiteboard with my pointer. This was one of the new clubs I'd set up: the Stock Club. Unlike the others, it was a different beast. I hadn't picked members based on how chummy they were with me, but on brains and drive. Sure, it was called the Stock Club on paper, but it was really an Economics Club in disguise.
It's for grooming my direct reports, after all. Only makes sense.
To deploy them right after they hit adulthood, they needed solid basics in economics and finance. Even a cynic couldn't call it weird. Wall Street was crawling with ace investors who'd been killing it before college graduation. Environment, passion, talent—that was the trifecta. And everyone in this room had it in spades.
Interest rates and bonds. Today's lesson.
"Okay, hands up if you don't know what an interest rate is."
A few flinches rippled through the room. Yup, clueless. Probably the ones who'd joined for my face. No way someone into finance wouldn't know rates... right?
"Interest rate means the rate of interest, got it? Oh, wait—do you even know what interest is?"
"...I know."
"For real?"
"..."
I stared down the boy. His face going beet red was kinda cute. Pfft.
"Haha, no sweat. At my level, you're all starting from scratch anyway... Except Ji-yeon—she's heard it all sitting next to me."
"Hear that? I'm on another level," Seo Ji-yeon boasted, shrugging with pride. She just looked like a pint-sized pup, though.
"Alright, quiz time for our Ji-yeon. What does it mean in the bond market when long-term rates dip below short-term—an inverted yield curve?"
"..."
Seo Ji-yeon clammed up like she'd swallowed honey. Face flushing, she stammered, "So, uh, long-term rates fall under short-term... um..."
"Enough. I get the picture. Hit the books harder, yeah?"
I was dying of boredom.
"Uh..., miss? So what's the answer?"
A familiar face piped up. Choi Do-ha, an early recruit—eager, sharp, and easy on the eyes. Not my type, but prime material. Looks and build were key to offsetting American racism. Trust me, I knew; those macho-obsessed Yanks...
I shook my head and schooled the boy I'd slotted as Ha Young-il's heir apparent.
"It's the spread between 10-year and 2-year Treasury yields. Normally, the 10-year's higher, but the gap narrows sometimes. Inverts on rare occasions. And when it does? Recession hits with damn near certainty."
"..."
Not clicking.
"Bonds first. Bond means debt—the 'bond' in obligation. English: bond, or fixed income. Right to lend cash."
Government issues Treasuries; companies, corporates. Key diff: bonds ≠ stocks. Stocks make you owner; bonds make you lender.
"Ah, so that's why interest? Ties to the rate."
Smart cookie—he nodded furiously, scribbling notes.
"Bingo. Big newbie trap: rates up doesn't juice your bonds. Prices tank."
"For real? Hang on, lemme guess, miss. Fixed income locks yield at buy-in. New bonds yield more if rates rise. Yield curve from that...?"
...Whoa. Low-key impressed.
"Nailed it. One point. Curve's a tad off, but skip the details."
I tossed Choi Do-ha a nod as he beamed back to his seat, then dove back in.
"Bonds got coupon rates and market rates. Market's the headline one. Coupon? Face rate at issue. You'll see 5% bonds, 10%—that's coupon. Worthless crap. Yield's what counts."
Thud. I slapped up a Fed funds rate chart.
"Why rates up = bond prices down. Check 1980: rates spiked hard under Volcker's squeeze—hit 19%. We were toddlers. T-bonds then? 20% yield. Who buys old bonds after that?"
Supply steady, demand craters → prices drop. Rates double as discount rates in bond land.
"...Bonds like CDs, right? Lend money, riskier than savings but better yield. Coupon useless?"
I jabbed the timeline.
"Hold to maturity? Sure. Ballsy enough for 10% while everyone's feasting on 20% safe? Be my guest."
"Ah... relative. Like day one: below-inflation returns = flushing cash."
"Spot on. Yield curve mention earlier? Bond market's packed with 10-, even 30-year paper. You parking cash for a decade—or three—untouched? Pensions only."
Sure, 19% policy rate warps from market expectations. Markets price in the future; no way that holds.
Seo Ji-yeon chimed in.
"Miss. Hold-and-get-yield, but selling at a loss feels off? Say $100 bond pays $105 total at maturity. Value's $105—why dump for $98...? Uh..."
Lightbulb. I grinned, poking the hole.
"Weird, huh? $100 bond jumps to $105 value instantly?"
No free lunch. Choices cost. Econ rule one. (Rule two: cost is the next-best alternative forgone.)
"World's priciest commodity? Time. Bond buyer traded time for $5. Bail early sans time cost? Pony up extra dough."
Every market good bakes in time value. Derivatives just supersize it.
Time: costliest, rarest, vital good. Not life—though near-synonyms. Equal to all, unfair as hell. Lucky us kids: plenty left. Young blood.
"Congrats. Richest brats on Earth."
A future Seoul National University econ prof once quipped: Bank of Korea's sorta independent from government, but tethered to the Fed. US policy rates rule the global roost.
"Ji-yeon, clicking now?"
I patted her gently.
"...Yeah. Rates hiking, right? Cleared the French bond shorts..."
France went low-rate temporarily—my Goldilocks mirage.
Why temp? Storm incoming.
"Fed's jacking rates. Sharp—2% over a year."
US at 3% now; year-end, 5.5%. Meh? Try $1 trillion+ vaporized from bonds.
Sorry, France. Pitch that élan vital passion—ride it out.