ORANGE COUNTY IN BANKRUPTCY : TERMINOLOGY OF TROUBLE

For a conservative area, Orange County went for some sexy investment vehicles. Here’s a look at some of the phrases you’ll hear in connection with OC’s fiscal woes.

Derivatives: Deals so complex that their creators’ personal computers aren’t big enough to handle the calculations. Orange County worked with various investment bankers, including Merrill Lynch and CS First Boston, to create investments whose values were derived from the direction of interest rates, and in this case the direction was headed down. Unfortunately for the county, interest rates did a U-turn in February, and the derivatives went south.

Reverse Repos: Short for reverse repurchase agreemtns. Using a security as collateral on a loan and using the loan to purchase another security. As long as the interest rate on the loan is lower than the yield on the security, the investor can use the difference to enhance his return. Reverse repos take advantage of the difference between the yield on a bond--say, 6%--and the loan rate on the borrowed cash, say 4%. The investor can purchase a security, use it to borrow against to buy another security, pay interest on the loan and come out ahead. The two-point difference means that a pair of securities at 6% each will yield 8%, as long as the loan rate stays lower than the bond yield.

Inverse floaters: Securities whose interest payouts and value fall as interest rates rise. Investors who buy them are betting that interest rates will fall.