90 The Management of Bond Investments and Trading of Debt
Because its interest payments are huge in relation to the principal, an IOette has a
very high price relative to its nominal amount. Since the IOette has only a little bit of
principal, the bond’s interest payments are great by comparison to the PO face
amount. In theory, there is no limit to the size of an IOette coupon, except that the
regulators might find out about this asymmetric risk and become inquisitive, which
creates a practical limitation.
If an IOette with $1.000 face amount paid interest of $800 a year for, say, 20 years,
then the investor would receive $16.000 of interest in total, though one might receive
interest for a shorter time period if the underlying mortgages were prepaid. As a result
of such a highly skewed cost and benefit margin, an IOette with a $1000 face value
might be worth many times more than that amount.
The possibility for scams comes from the fact that the aforementioned highly
skewed cost and benefit makes the IOette a first-class candidate for twisting the
P&L statement through imaginary, if not outright fake, profits. On the one hand,
the zero-coupon strip qualifies as the discount part, as it is worth much less than
its face amount. On the other hand, taken together IOettes and zeros become a
sort of modern financial alchemy which can deceive practically everybody – even
the experts.
4.9 Brady bonds and Rubin bonds
Named after former US Treasury secretary Nicholas Brady, who invented them in
the late 1980s, Brady bonds represent the restructured bad debt of Latin American
and other emerging countries that overborrowed from US credit institutions all the
way to default. These bonds were designed to prevent financial meltdown for
lenders and borrowers:
Bradys are normally collateralized by US zero-coupon bonds of various maturities.
Hence, their principal is guaranteed but most bonds’ coupons are not.
The algorithm is that if a country cannot make its interest payments, investors can
at least collect 100% of their principal when the bonds come due. The risk is that
investors lose out on interest, and they have tied up their money for years instead of
putting it into a yield paying investment. That’s the downside.
Because defaulting Brady bonds no longer pay interest, their value in the sec-
ondary market plummets to only a fraction of their face value. This makes the
Brady bonds market highly volatile, reacting to moves in US bond prices and espe-
cially to bad news from emerging nations, such as the Mexican peso devaluation
of late 1994.
In spite of the aforementioned risks, insurance companies and other institutional
investors as well as hedge funds, have been willing to take that chance. According to
the management of US open-end mutual funds dedicated to emerging-market debt,
Brady bonds have gone mainstream and they are trading cross-country.

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