1w FinEcon 2024fall v1

Summary

Professor Caleb Kim introduces the course on Financial Economics, covering financial transactions and products. He shares his background, including his education at Korea University and a PhD from HUK University, focusing on market instruments like OIS and IRS. With experience as Chief Risk Officer at Numa Korea, he discusses his expertise in financial risk management, particularly in the OTC derivatives industry. The course will explore financial instruments, derivatives, and risk management, aiming to provide a comprehensive understanding of financial markets.

Takeaways

• 📚 The course focuses on Financial Economics, covering financial transactions and products.
• 👨‍🏫 The instructor, Caleb Kim, has a background in financial engineering and has worked extensively in financial risk management.
• 🎓 Caleb Kim's educational journey includes a Bachelor's from Korea University, a Master's in financial engineering, and a PhD from HUK University of Foreign Studies.
• 🏢 He has professional experience at NH Investment Securities and Numa Korea, where he was the Chief Risk Officer.
• 💼 Caleb Kim's expertise lies in managing market risk, credit risk, regulatory risk, and operational risk in the OTC derivatives industry.
• 📈 He was part of a working group that established the KRW risk-free rate, which is a significant development in the Korean financial market.
• 🌐 The course will explore financial instruments like futures, options, and swaps, and their role in risk management and market operations.
• 📖 Recommended reading includes 'Fundamentals of Futures and Options Markets' by John C. Hull, available in both English and Korean.
• 💡 The course aims to provide insights into financial instrument dynamics, price setting, and effective financial risk management.
• 🌟 The concept of financial economics is illustrated through the life cycle consumption and income graph, highlighting the need for financial tools to balance income and consumption over time.

Q & A

What is the name of the instructor mentioned in the script?

The name of the instructor is Caleb Kim, but he prefers to be called HKB.

What is the instructor's area of expertise?

The instructor's area of expertise is Financial Risk Management, particularly in the OTC derivative industry.

What does OTC stand for in the context of the script?

OTC stands for Over-The-Counter, which refers to financial products traded outside of exchange markets.

What is the role of CSA in OTC derivative trading?

CSA stands for Credit Support Annex, which is a self-contained contract that forms part of the ISDA Master Agreement. It explains what collaterals can be used and how to post and take them back, including the costs involved.

What is the significance of the KW risk-free rate mentioned in the script?

The KW risk-free rate is a rate that is nearly risk-free, with a default probability close to zero. It is used as a reference rate in financial markets and was established by a working group that the instructor was a part of.

What was the instructor's contribution to the establishment of the KW risk-free rate?

The instructor was part of the working group that discussed and decided on the KW risk-free rate, engaging in discussions with the Bank of Korea (BOK), the Financial Supervisory Service (FSS), and the Korean Exchange (KRX).

What is the difference between a traditional interest rate swap and an overnight index swap?

In a traditional interest rate swap, one party pays a fixed rate and receives a floating rate like LIBOR. In an overnight index swap, the floating rate is based on an overnight rate index, such as SOFR or SONIA, which reflects the cost of borrowing overnight.

What is the purpose of the course on Financial Economics mentioned in the script?

The purpose of the course is to study various financial instruments and markets, focusing on how they work together, how prices are set, and how to manage financial risks effectively.

What are the key areas covered in the lecture plan for the Financial Economics course?

The key areas covered include introduction to financial derivatives, future and forward contracts, option pricing models, option trading strategies, and swap and risk management.

What is the recommended textbook for the course, and is there a Korean version available?

The recommended textbook is 'Fundamentals of Futures and Options Markets' by John C. Hull. Yes, there is a Korean version available for those who prefer to read in Korean.

How does the instructor plan to make the course material accessible to students who might not be familiar with financial jargon?

The instructor plans to present the material in a simple, concise, and easy-to-understand manner, focusing on key concepts from each topic to help students grasp the essentials and manage their financial wealth and career.

Outlines

00:00

🎓 Introduction to Financial Economics and Instructor's Background

The speaker, Caleb Kim, introduces the topic of Financial Economics for the semester, focusing on financial transactions and products. He provides his contact information and shares his educational background, including degrees from Korea University and a PhD from HUK University. Caleb's professional experience includes working in financial risk management at NH Investment Securities and as Chief Risk Officer at Numa Korea, where he managed various types of risks. He also discusses his involvement in establishing the KRW risk-free rate in South Korea.

05:04

📈 Understanding OTC Derivatives and Credit Support Annex

Caleb explains the concept of Over-The-Counter (OTC) derivatives, contrasting them with exchange-traded derivatives. He discusses the Credit Support Annex (CSA), which is part of the ISDA Master Agreement used in OTC derivative trades to manage credit risk. He also mentions his role in the establishment of the KRW risk-free rate by the Bank of Korea and the shift from term rates to overnight rates following the 2008 financial crisis.

10:05

🌐 The Evolution of Risk-Free Rates and the Impact of the Financial Crisis

The paragraph delves into the history of risk-free rates, highlighting the 2008 financial crisis's impact on the perception of swap banks' risk profiles. It discusses the global shift from term rates to overnight rates as risk-free benchmarks, with a focus on the establishment of the KRW risk-free rate in Korea. Caleb's involvement in the working group that discussed the creation of this rate is also highlighted.

15:09

📚 Course Overview and Financial Instruments

Caleb outlines the course structure, emphasizing the study of financial instruments and markets. He mentions that the course will cover basic derivative products like futures, options, and swaps, and will teach how to set prices and manage risks. The course aims to provide insights into financial markets' dynamics and operations, with a focus on practical application.

20:12

💼 Financial Risk Management and Recommended Reading

The speaker discusses the importance of financial risk management and the key areas the course will cover, including future and option markets. He recommends the book 'Fundamentals of Futures and Options Markets' by John C. Hull, suggesting both English and Korean versions for students. Caleb emphasizes the relevance of understanding financial economics concepts for managing personal financial wealth and career development.

25:14

🌱 Life Cycle Consumption and Income Management

Caleb introduces the concept of life cycle consumption and income, explaining how individuals' income and consumption patterns can vary throughout their lives. He discusses the challenges of managing the gap between income and consumption and the strategies people use to smooth out their consumption streams, such as borrowing or investing. The paragraph aims to illustrate the practical applications of financial economics in personal financial planning.

Keywords

💡Financial economics

Financial economics is a branch of economics that studies the behavior of individuals, businesses, and organizations in financial markets. It encompasses the analysis of financial instruments, markets, and institutions. In the video, the speaker introduces financial economics as the main theme for the semester, indicating that the course will explore various financial products and transactions, which are central to understanding financial economics.

💡Financial products

Financial products refer to assets or contracts that are traded in financial markets. They include stocks, bonds, derivatives, and other instruments. The script mentions that the course will cover a variety of financial products, highlighting the importance of understanding these products in the context of financial economics and how they are used in transactions.

💡Financial Risk Management

Financial Risk Management is the process of identifying, evaluating, and mitigating risks associated with financial transactions and investments. The speaker discusses his experience as a Chief Risk Officer, emphasizing the significance of managing market risk, credit risk, and other types of risks in the financial industry.

💡OTC (Over-The-Counter) derivatives

OTC derivatives are financial instruments that are traded directly between two parties, without going through an exchange. The speaker mentions his specialization in the pricing of customized OTC products, which is a crucial aspect of financial economics as it involves understanding the valuation and risk associated with these instruments.

💡CSA (Credit Support Annex)

A CSA is a legal agreement used in OTC derivative transactions that specifies the terms under which collateral can be exchanged between counterparties to mitigate credit risk. The script explains that CSA is part of the ISDA Master Agreement, which is essential for understanding the contractual framework in financial transactions.

💡Risk-free rate

The risk-free rate is the theoretical return of an investment with zero risk. It serves as a benchmark for pricing other investments. The speaker discusses the concept of risk-free rates and how they have evolved, particularly in the context of the global financial crisis, emphasizing the importance of understanding these rates in financial economics.

💡Interest Rate Swap (IRS)

An Interest Rate Swap is a type of derivative contract in which two parties exchange interest payments calculated using a notional principal amount. The speaker's academic focus on IRS and the pricing of customized swap transactions illustrates the practical application of financial economics in managing interest rate risk.

💡NH Investment Securities

NH Investment Securities is a financial institution where the speaker worked, focusing on financial risk management. This example from the script highlights the real-world application of financial economics principles in a professional setting.

💡KRW risk-free rate

The KRW risk-free rate refers to the benchmark interest rate for the South Korean won that is considered to have minimal risk. The speaker's involvement in establishing this rate demonstrates the practical aspect of financial economics in shaping financial market standards.

💡Yield Curve

The yield curve is a graphical representation of the interest rates on debt for a range of maturities. Although not explicitly mentioned in the script, the discussion of interest rates and financial products implies the concept of the yield curve, which is essential for understanding the pricing and risk of fixed-income securities.

💡Life cycle consumption and income

The life cycle consumption and income model is an economic theory that suggests individuals smooth their consumption over their lifetime to maintain a consistent standard of living. The speaker uses this concept to illustrate the gap between income and consumption, which is a fundamental issue in financial economics that financial products aim to address.

Highlights

Introduction to Financial Economics and the course's focus on financial transactions and products.

Instructor Caleb Kim's background, including his education and experience in financial risk management.

Caleb's preference for being called 'Kop' and his contact information for student inquiries.

Caleb's academic journey, with degrees from Korea University, K, and a PhD from HUK University of Foreign Study.

His specialization in OTC derivative industry and experience as Chief Risk Officer at Numa Korea.

Involvement in establishing the KRW risk-free rate and working with the Bank of Korea.

Explanation of the difference between exchange and OTC markets in the context of financial derivatives.

Discussion on the 2008 Global Financial Crisis and its impact on the perception of risk-free rates.

Introduction to the concept of overnight index swaps (OIS) and their role in financial markets.

Caleb's receipt of an outstanding paper award through the KX academic support program.

Course overview, including the study of financial instruments, markets, and their interactions.

Objectives of the course: to introduce basic concepts of future, option, and swap markets.

Outline of the course content, covering financial derivatives, pricing models, and risk management.

Recommendation of the book 'Fundamentals of Futures and Options Markets' by John C. Hull.

Discussion on the concept of financial economics and its application to life cycle consumption and income.

Importance of managing the gap between income and consumption for financial stability.

The goal of smoothing lifetime consumption to match income generation for optimal financial planning.

Transcripts

hello you guys um the topic uh we are

going to cover is uh Financial economics

for this semester today uh in know the

first week so we go through

orientation and I will uh you know give

you a taste of financial uh

transaction uh including uh various

Financial

products

yeah firstly uh let me give you uh you

know some introduction of

myself um my name is Caleb Caleb uh Kim

so you just call me H KB and Korean name

is uh

Kimu uh lat you know if you are familiar

with the Korean and please uh call me in

a techim so either way uh is okay but I

prefer to be called kop than Korean

name email ID uh hello risk and hand

mail net please uh you know remember

this one and my my mobile is like this

so during uh your studying uh you know

if you have any question or query please

send me uh to my uh email or mobile so

when I uh get it I will uh try to uh

respond you uh as soon as

possible education that what I got from

uh

1982 to

1988 I went to uh Korea University I

studied uh economy so I got Bachelor

degrees from uh Korea University long

ago from Mar from March 1997 to February

1998 I um I I went to uh K which is one

of one of uh graded uh School in uh

Korea I from uh from

K I got a master degrees in financial

engineering from uh 2014 to

2020 I got a PhD in huk University of

Foreign uh study so where I studied I

focused on some Market including uh you

know

ois and uh

IRS IRS stands for interest rate

Swap and the pricing uh of calized swap

transaction

Etc where I worked

for uh since since 2001

to6 I worked at one of local security

houses which is NH investment

Securities my major uh job

was uh regarding uh Financial Risk

Management

uh from 2006 to

2023 I worked at Numa Korea for 17

years I was I had been uh Chief risk

officer to uh govern and the risk manage

Market risk and credit risk and what

else regulatory risk and even

operational uh

risk those are my area uh I covered as a

chief risk officer in financial fund

since uh

2006 okay uh my

highlight uh dedicated to Financial Risk

Management within OTC derivative

industry maybe you're not familiar with

the OTC this stands

for over

the

counter what is reverse what is the

opposite uh concept uh against

OTC

Exchange

exchange means like uh you know you can

see uh you know KX in Korea that is uh

you know Exchange

Market over the counter derivative

means

OTC derivatives product are traded

outside of outside of

exchange so this is called OTC dtive

industry through uh through my uh you

know whole uh

life um I uh you know I covered

Financial Risk Management Area

especially uh in uh OTC dtive

industry okay uh specialized in the

pricing of calized OTC Dy product based

on uh CSA CS say maybe not familiar as

well says say stands

for say say stands

for

credit

support

anx when you trade uh OTC T tips with

the the the uh

counterparty basically you need to

assign

EA

Master agreement this is Regal

agreement by the way uh you know some

terminology uh you're not familiar with

then uh you can uh you know ask me or

you if you uh you know if you uh you

know answer uh your question into uh

chat GPT and this one uh friendly and

kindly gives you back uh answer so I

think uh uh it's a lot helpful you can

you need to you you you

maximize uh in a chat GPT so either way

uh um credit support Annex is

s self

contract of

Isa Master

agreement this CSA um this

sessay explains what uh what could be uh

collaterals and how to uh you know how

to uh give it how to post and uh take it

back what is cost of uh you know C Etc

so this uh uh this is what this is about

and I involved in establishing KRW risk

free rate read by a b working group b is

Bank of Korea this is Central Bank in

Korea here you know you see the KW risk

free rate risk free rate means what risk

free risk free means no risk or uh

nearly nearly

uh nearly close to zero

risk in uh in other

words

risk free

means

default of

probability oh sorry uh let me uh

change default

probability is close to uh zero so no

default probability so that's the

definition of for risk

free in the market then you may see uh

you know a risk free rate in uh

USA so

far you can enter this uh you know so

far into CH B and it can give

you a lot of wonderful answer uh back to

you

h

and

Sonia yeah those are part of uh you know

risk free rates risk uh reference free

rates before uh

2 8 you know 2008 you know do you know

what happened there led by uh led by

subprime U mortgage instant from USA and

2008 the Global Financial uh crisis

broke out so during uh you know this uh

uh Global financial crisis most of swap

bank they are you know they were under

of funding uh shortage so some uh

Financial form such as reman

brothers uh they uh went on bankrupt so

during that period people uh

understood swap Bankers are not uh risk

free they are they will uh potentially

exposed to uh default risk so since that

time people uh you know are reluctant

people were reluctant to use so-called

Rial

or

uo these are tomate three

months tomate they not they were not

willing to use it because these are

these

were these were uh uh these were

recognized by market

participant uh it's not it was not risk

free so so major uh major uh countries

and

major uh regulatory bodies they are

determined to remove they determin to

reform uh in a benchmark rate from term

rat

to uh one day overnight rate one

day

overnight

rate so when when you know when it comes

to uh risk free rate these days then you

know you can think about uh sofa and

Tona and Sonia such as overnight rate so

overnight rate means you rent some money

to your friend overnight then probably

you know your your friend still uh is

not strong from a financial perspective

but you may uh you know discount while

uh

his uh default probability would be

would be uh close to zero that would be

possible so w rate uh you know

recognized by market participant these

are risk free or these are

you know these uh don't

have credit risk at all so in Korea in

Korea up until uh

20 101 I believe uh there we uh didn't

have KW risk free rate that's why B set

up a working group and invited Mar

participant from Financial forms

including Banks and security houses uh

you know the group talked about how to

uh you know establish KW risk free rate

I was a part of those uh working group

and uh you know discussed how to uh

which uh you know how to uh uh

decide KW risk free rate

Etc after that engage in discussion with

uh FSS FSS is uh local regulator in

Korea and B I already mentioned and the

KX this is Exchange Market in Korea uh

on the on the topic of KRW Ys Market Ys

Market means what Ys Market

means

overnight

index

swap yeah over index

swap to um uh before uh in know

introduction of Ys uh let me uh go to

rival first so rivos means

what Rios means

let me

erase rival swap means let's say uh

interest

rate so so

now you and this is

Bank typical uh interest swap uh you

enter is like this

you pay uh fixed coupon such

as

uh 10 year swap you pay a fixed

coupon

5% and instead you

receive what Lial such

as

this

is floating

rate floate

means uh from uh today maybe three

months rate already fixed but uh 3

months after 3 months 3 months after 9

months 3 months after one year you know

that's not that's not decided so you're

not uh uh it's a

uncertain rival goes up or goes down

that would be

possible that this is one of a typical

example of interest rate swap however

overnight index

swap is uh looks like a very uh you know

similar but different one

is yeah

Bank y you pay fixed

coupon however you

receive you

receive s far

Ora so far TOA this case these are

index of course uh you know how to uh

how to uh this side floating rate coupon

you know relatively uh not simple but uh

this is basic concept for overnight

index swap so in in Korea uh we uh we

don't have uh KW W Market so uh now we

need to set up kwi Market based on what

of

far

this is uh KW risk reference rate in

Korea final one I received outstanding

uh paperwor through kis KX academic

support program

in 20 20

okay yeah lecture plan for this semester

course overview this course

incompasses the study of various

financial instruments and market and

their interaction so you will focus on

how financial instruments work together

and learning about basic WC derivative

products like future and option and

swap uh if you uh never heard uh about

uh you know future and option and swap

well don't worry about it I will try to

uh you know I will try to lead you as

easy as possible so don't worry about I

just take it uh simple and concise and

easy for you through this course you

will uncover how prices are set how

risks are managed and how Financial

Market operate in

practice and cuse objectives to

introduce a basic concept basic of

future and option and swap Market to

gain insight into various Financial

instrument and the market Dynamic uh to

understand how prices are set and how to

manage Financial Risk effectively well

you know uh it's not really like uh

touching uh you know your mind but uh uh

going through going through uh each uh

you know topic by week uh you not you

are uh growing uh to understand uh what

these are okay re of contents uh

introduction to financial derivatives

and future and forward option option

pricing models option trading strategy

Swap and risk management the ma main uh

key areas uh we are going to cover

through this uh in our lecture all

right next B uh left hand side uh

fundamentals of uh future and option

Market by uh John H John H is of one of

famous uh figure in the financial

Industries this is excellent book if you

uh you know like to read uh Korean then

we have you know Korean version at the

same time so either uh you know English

version or Korean version please uh buy

one uh one uh copy and uh read it

through uh day by day uh this is very

excellent and then you more if you are

you know not well ready to uh understand

whole but don't worry about it you just

take some key uh concept uh from uh each

topic that would be uh really helpful uh

for you to uh manage your financial

wealth and your career I

think yeah you know this uh semester uh

with you the topic we are going to cover

a

financial economics where probably you

may heard economics but what is

financial economics what's the concept

of this uh you know

topic let me give you one example yeah

life cycle consumption and income uh

graph here this one

is income uh graph

well this is one example but the you

income not always matchy uh you know

this uh

graph the other

one consumption uh graph this

one a

consumption

graph all

right let's see this part

there is a gap between uh consumption uh

and income which means you need you need

more money to uh you

know to to support your

consumption but your income is less than

uh less than your consumption so there

is a

gap then what what what are you going to

do to fix this Gap probably you need

more money but uh you income is limited

then uh you can borrow some money from

your friend your

family from yeah from Like A

banks that should be happening

otherwise you can't uh

survive look at this

area your income rather than your

consumption which means you have Surplus

so what you're going to

do

definitely you need to invest for future

consumption and this part

again your consumption is bigger than

your income this is another homework you

need to sort

out

okay these are this is life cycle

pattern of income

generation and consumption

spending however your income generation

and consumption spending are not

identical are not the same uh that's

where you home is arising so typically

you have you have General preference for

what smooth lifetime consumption stream

which means which means if you make your

income generation just like a

consumption graph then that would be uh

really perfect you don't worry about uh

you know you don't worry about gap

between consumption and income anymore

because

because uh let me

erase yeah because you like

to you like to make this

consumption through your whole

life so at the same time your income is

just like this then there is no Gap that

this is the goal we targeting so what

you're going to do for reducing

Gap