Word: bonding
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...possible that your mortgage has been chopped in half -- with the principal portion sold off and bundled up into a P/O, which stands for "principal only," and the I/O, "interest only," going another way. Bond funds use I/O derivatives to add yield to their portfolios and make aggressive bets on the direction of interest rates...
Derivatives, which are based on such real assets as stocks and bonds, work like most professional betting games. They have a zero-sum outcome, always producing a winner and a loser. The bettors put up their money, and the people who run the casino -- a bank, a brokerage house or an insurance company -- figure out ways to pass on the risks. Companies use derivatives to hedge against changes in interest rates, foreign-exchange rates and commodities prices. Mutual funds and pension funds use them to protect their stock and bond investments. Major banks, brokerage firms and insurance companies write them...
Derivatives have clearly heightened the anxiety in stock, bond and currency markets around the world in the weeks since the U.S. Federal Reserve began raising interest rates for the first time in five years. The Fed's move on Feb. 4 led the aggressive speculators who run high-rolling investment vehicles called hedge funds, which use derivatives in daily trading, to dump billions of dollars' worth of bond futures and thereby drive down the prices of the underlying bonds. The worst fallout occurred in Europe, where bond prices plunged and interest rates, which move in the opposite direction of prices...
...turmoil in the bond derivative market, which has persisted since February, has troubled Wall Street watchers because it bears some of the hallmarks of the 1987 stock-market crash. That 508-point plunge on Black Monday was worsened by so-called portfolio insurance, which is computerized programs designed to bail investors out of stocks in a downturn by selling stock futures. But few buyers were willing to come forward while so many others rushed for the exits, and the decline accelerated instead of slowing down...
Regulators have had two good excuses recently to push their oversight of derivatives. Typically, derivatives contracts make up anywhere from 2% to 10% of the assets of the mutual funds that hold them. But the managers of a $385 million government-bond fund called Hyperion 1999 Term Trust got carried away last fall. The trust put nearly one-third of its money into derivatives contracts that amounted to bets that interest rates would not drop anytime soon. When they did drop, the value of the trust's shares plunged about 25%. Just last week, a group of investment funds...